Active Risk

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Active Risk

Active Risk

The risk a portfolio or fund acquires when it is actively managed, especially when its money managers attempt to outperform some benchmark. That is, the more a fund or portfolio differs from the benchmark upon which it is based, the more likely it is to underperform or outperform that same benchmark. This extra risk is active risk.
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One way to think about active risks is to group them into "top down" and "bottom up" categories.
80 10 Sum of Standalone Active Risks Less Diversification Benefit Total Active Fixed-Income Tracking Error (annualized) Target Gross Excess Return (annualized) Active Risk Information Ratio Optimized Target Active Strategy Basis Points Duration/Yield Curve 45 Country Exposure 25 Sector Rotation 39 Security Selection: Government/Agency 10 Mortgage-Backed/Asset-Backed 25 Securities Corporate Credit 30 High Yield 10 Emerging Market Debt 10 Sum of Standalone Active Risks 192 Less Diversification Benefit -92 Total Active Fixed-Income Tracking 100 Error (annualized) Target Gross Excess Return 90 (annualized) Active Risk Information Ratio 0.
First, active risk is taking portfolio positions that are different from the benchmark.
One example of active risk is to position the portfolio based on one's view of the direction of interest rates.
Once the insurer determines that it is willing to take active risk (deviate from the benchmark), it should determine how much active risk it is willing to take.
It is the active manager's job to consistently generate returns above the benchmark by taking active risk.
Lastly, we believe there are diversification benefits from combining different sources of active risk.
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