Darien

If the manager adds "true active return" then the completeness fund would just be stripping away the "misfit return"

Argghh...What on earth does the author mean by "a nonzero amount of misfit risk may be optimal" and how does "In seeking to eliminate misfit risk [sponsor gives up] some of the value added from the stock selection of the active managers" ?

pennyless

All hypothetical and really over the top.

i.e. I really really really like Energy and I really really really like XOM in energy.

Energy is 18% of the SPX. I buy 20% XOM.

I am overweight Energy to the benchmark and overweight XOM extremely. I have misfit risk which the completion fund would take away the energy sector overweight and my active return of XOM which the completion fund would not get rid of.

Overall, XOM outperforms energy by .5% but energy outperforms by 10%. I have outperformed due to to 2 bets. Energy overweight and XOM overweight. That is the non 0 amount of misfit risk. It allows sector and active bets.

If the manager put 100% of the portfolio you would want to get rid of misfit risk however.

Think of it as the within-sector and allocation effects portion of Performance Evaluation.

(weight portfolio - weight benchmark) (return portfolio - return benchmark)



Edited 2 time(s). Last edit at Wednesday, May 18, 2011 at 02:47PM by Paraguay.