I think it has to do with the risk of the pension fund, and it is already having funding shortfalls, + the fact that you are a fiduciary position. Increasing risk by taking on leverage in the form of Short selling - would not be advised.
additionally - just by taking on double the risk - you do not and cannot double the rewards.
When are you going to get 2012 books?
I have 2012 e-books which I use to check with 2011 books incase there is any change hence page number mismatches.
so whats the correct answer to this Q, does anyone know?
I have serious problems with CFAI explanation. IC is a constant. Why should a manager all of a sudden become dumber (IC decreases) when they take on more active risk? Do all of the forecasts change? And if greater tracking error is allowed, could not a manager now invest outside of the benchmark thus increasing Breadth?
Another formulation of the Fundamental Law of Active Management from 2002 FAJ includes a term called transfer coefficient: IR ~ TC * IC * sqroot(Breadth). The transfer coefficient measures how constraints impact the information ratio. As constraints (short-selling, turnover, long-only, quality, concentrations, ect) increase, less of a manager’s investment insight is transfered into the portfolio.
From EOC 27 #8, "“the long-only constraint increasingly limits the portfolio manager from taking full advantage of her investment insights…the IC falls because a smaller portion of the manager’s insight is translated into the portfolio.”
The CFAI material never discussed the negative impacts of constraints on IC until this question. If the answer is related to TC, I still disagree with the CFAI response. Increased tracking risk is a reduction in the constraints a manager faces. If the long-only constraint were to still apply, the portfolio could become more concentrated in high conviction positions.
i agree. i immediately had similar misgivings about how they presented this, along your lines of thought, but it’s CFAI and thats what they want so thats what they will get. the most important thing to know really is that it’s not a linear relationship and doubling assets wont lead to the same IR.
I don’t think IC is a constant. IC is the correlation of your forecasted return with your actual return. I can see that changing over time. Like maybe when your forecasted return isn’t able to be actualized due to the long only constraint.
Yes, IC is not a constant over time, but your accuracy / investment insight (IC) should not be effected by portfolio constraints. However, the portion of your investment insight incorporated into the portfolio returns is directly effected by constraints. Just because an investment insight (IC) is not incorporated into the portfolio doesn’t lower the correlation between your forecasted returns and actual returns.
The IC is the correlation between the forecasted alpha and actual alpha.
Doubling tracking risk will cause forecasted alpha to be more dispersed on the long AND short side (Since risk is both positive and negative deviation from the mean)
Since alpha, in this case, can only be exploited on the long side, the forecasted alpha reflected in the portfolio’s holdings will be less correlated to actual alpha since actual alpha turns out to be both on long and short positions. Suzuki knew that actual alpha will be both long and short but she could not take advantage of this insight since she couldn’t go short.
Less correlation means a lower IC.
A lower IC, keeping the square root of breadth (# of stock picks) constant, leads to a lower information ratio. (Given the formula IR=IC x square root of breadth)