Constraints and added costs impact Active return, active risk and Information ratio

CFA Level III Equities
#1

Hi,

I have question regarding how implementation constraints impact information ratio.

In the reading 29 (page 480) and EOC 5, it is stated that “leveraging the active risk will not proportionally increase the active return in the presence of constraints and added costs”.

And in EOC 5 it goes on that “_ If there were no constraints preventing the new fund from scaling up active weights, it could scale up active risk by scaling up active weights, proportionally increase active return, and keep the IR unchanged. Implementation constraints experienced by the new fund, however, such as the cost and difficulty in borrowing securities to support the scaled-up short positions, will prevent the active return from proportionally increasing with the active risk. _”

I understand how the added costs may impact the information ratio. However, I do not understand how can constraints (such as difficulty to borrow securities) impact IR? If fund is not able to enter into a short position, it should not impact Active Return or Active Risk since no action has been taken.

#2

Difficulty to borrow= increases borrowing cost= reduces active return=IR impacted such that expected active return is more than realized active return

“leveraging”= need to borrow

my .02

#3

I think it has to with Exhibit 14 on p480.

He can’t get higher on the line (closer to B’s characteristics while keeping the IR the same), because of the constraint of not being allowed to short.

So its relative to B, in the case of ex14.