A new reading has been added to Level 2 Portfolio Management (2016 curriculum) - “Analysis of Active Portfolio Management”. In the section 3.3 Constructing Optimal Portfolios, the reading talks about 3 formulas / concepts which are not well explained.
1. Optimal portfolio allocation between actively managed and benchmark portfolio would maximize the sum of squared Sharpe Ratio of Benchmark and Information Ratio
SR(P)^2 = SR(B)^2 + IR^2
2. For unconstrained portfolios, the level of active risk that leads to the optimal result is
𝜎𝑅𝐴=𝐼𝑅𝑆𝑅𝐵𝜎𝑅𝐵σ(RA)=IR/SR(B) σ(RB)
3. Total Risk of the actively managed portfolio is the sum of the benchmark return variance and active return variance
Can someone please through some light on these formulas - their derivation or how did we get here.
1. Optimal portfolio allocation between actively managed and benchmark portfolio would maximize the sum of squared Sharpe Ratio of Benchmark and Information Ratio
SR(P)^2 = SR(B)^2 + IR^2
2. For unconstrained portfolios, the level of active risk that leads to the optimal result is
𝜎𝑅𝐴=𝐼𝑅𝑆𝑅𝐵𝜎𝑅𝐵σ(RA)=IR/SR(B) σ(RB)
3. Total Risk of the actively managed portfolio is the sum of the benchmark return variance and active return variance
Can someone please through some light on these formulas - their derivation or how did we get here.