Optimizing Managers on Active Risk

Marc Odo
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AllocationADVISOR users are frequently puzzled by the results of their analysis if they select managers rather than market indices at the inputs to a mean variance optimization (MVO). The goal of optimizing active managers is the same as it is for optimizing asset classes, that is, to maximize return and minimize risks. However, the results tend to lead to recommendations that no one in their right mind would follow.

Mean-Variance Optimization

Given the inputs (returns, standard deviations, and correlations), AllocationADVISOR determines the applicable range of possible returns by finding the return of the minimum variance portfolio (MinVarReturn) and the return of the asset with the greatest expected return (MaxReturn). AllocationADVISOR’s optimizer finds the combination of assets that minimizes the risk for each of 100 return points within this range. Thus, the efficient frontier is made up of 100 efficient portfolios.


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