Active Portfolio Management

Active Vs. Passive Management

Passive tracking a benchmark portfolio
Active outperform the benchmark portfolio
Timing beta management
Excess returns Sector or Security selection alpha management

Market equilibrium is an outcome of Active

Management

Applicable for efficient/nearly efficient markets

also

Active Vs. Passive Management

Cost of Active Management:
Forecasting
Diversifiable risk
Transaction costs
Capital gains taxes

Empirical evidences

Measurement for Active Management

Active returns

Return differential of a portfolio compared to a

benchmark
Portfolio return benchmark return

Tracking Error

Variation of returns of a portfolio compared to a

benchmark
Std. Deviation of active returns

Information Ratio
Alpha average active returns over time
Port
Benchmark Active
Returns
Returns
returns
3.1
3
0.1
2.1
2
0.1
5.1
5
0.1
5.1
5
0.1
1.1
1
0.1
2.1
2
0.1
3.1
3
0.1
3.1
3
0.1
5.1
5
0.1
1.1
1
0.1
Average
(alpha)
0.1
Stdev
0.00

Port
Benchmark Active
Returns
Returns
returns
3.1
3
0.1
2.1
2
0.1
5.1
5
0.1
5.1
5
0.1
1.1
1
0.1
1.9
2
-0.1
2.9
3
-0.1
2.9
3
-0.1
4.9
5
-0.1
0.9
1
-0.1
Average
(alpha)
0.00
Stdev
10.54%

Tracking Error
Backward looking

Not responsive of current reallocation in beta and

sectors
Useful for actual performance evaluation

Forward looking

Problems in forecasting variables

Useful in risk management and defining factor
exposures

Determinants

Number of assets; market volatility; portfolio beta

Treynor-Black Model
Optimal portfolio for an investor has allocation to
both, active and passive portfolios
Assumption:
Markets are nearly efficient
Ri R f .( Rm R f ) i
Ri R f .( Rm R f )

i Ri Ri

i
2

( i )
wi

2
i 1 ( i )
N