Question #5
Reading: Reading 40 Analysis of Active Portfolio Management
PDF File: Reading 40 Analysis of Active Portfolio Management.pdf
Page: 2
Status: Incorrect
Correct Answer: B
Your Answer: A
Question
An active manager currently covers 40 stocks and makes a forecast for each of them every quarter. Next year he intends to cover the same stocks but only once every 6 months. Assuming the manager's skill, measured in terms of the correlation of each forecast with actual returns doesn't change, which of the following statements is most accurate?
Answer Choices:
A. The information coefficient will fall by approximately 50%
B. The information ratio will fall by approximately 30%
C. The information ratio will fall by approximately 50%
Explanation
Information ratio (IR) = IC ×
Hence a reduction in the breadth from 160 (40 × 4) to 80 (40 × 2) will cause an
approximate 30% drop in the IR
With quarterly predictions
IR = IC × 160½
= 12.65 (IC)
With semi-annual forecasts
IR = IC × 80½
= 8.94 (IC)
8.94IC / 12.65IC = 0.701
Hence the Information Ratio will fall by approximately 30%. Note that full calculation is not
required. Given that IR changes with the square root of breadth, a 50% drop in breadth
must cause a less than 50% drop in IR. Note that it does not matter if the portfolio is
constrained or unconstrained.
(Module 40.3, LOS 40.c)
√BR