Equity Portfolio Manager active Risk and Information Ratio

Abstract

Do high active risk (AR) equity portfolio managers tend to realize a relatively high information ratio (IR)? We explore the AR-IR relationship across various global equity mandates and investment approaches. When evaluating managers, a CIO may choose to compare managers that share a common investment approach (i.e., fundamental or quantitative) or group all managers together. Recognizing that managers with a fundamental or quantitative investment approach may have inherently different active risks, we compare High AR against Low AR managers, with and without controlling for manager investment approach. We examine managers with the following investment mandates: Large cap (US) equity, developed market excluding North America (EAFE) equity and emerging market (EM) equity. We find that the AR-IR relationship varies across mandates. The IR gap between Low AR and High AR managers tends to be high when the market is characterized by scarce alpha opportunities (i.e., efficient markets) or/and challenging risk measurement environments (i.e., hard to forecast volatility). For US mandates, the average High AR fundamental manager had a better IR compared to the average Low AR fundamental manager. In contrast, the average US Low AR quantitative manager had a better IR than the High AR quantitative manager. For EAFE mandates, the average High AR manager, either fundamental or quantitative, had a better IR than the EAFE Low AR investment manager. In contrast, for EM, the Low AR portfolio, either fundamental or quantitative, had a better IR than the EM High AR portfolio.