An Equity Portfolio Framework for Combining
Active Management and Index-Based Implementation

Abstract

The proliferation of liquid, transparent, and inexpensive index-based implementation means that nearly all types of investors, individual and institutional, face a persistent portfolio implementation question regarding the allocation between active managers and index-based strategies.

Placing active risk from active fund management in the same framework of uncertainty that asset allocators utilize for other portfolio decisions brings to the active versus passive debate a surprising and enlightening answer that does not match typical discourse on the matter. Instead of a binary, “all or none” answer, reasonable (and even optimistic or pessimistic) expectations for active management imply a balanced implementation approach. Only extreme assumptions (e.g., very positive or negative levels of active return, very short or long time horizons) indicate a binary choice.