Active risk
The standard deviation of active return, also called tracking error. Its square splits into active factor risk and active specific risk.
Where you will meet it
Active risk appears in 30 learning outcomes on the CFA syllabus. A few of them:
- Set out ways to build ESG considerations into planning and constructing a portfolio
“Screens shrink the investable universe, so they can raise tracking error against a conventional benchmark and alter the portfolio's risk profile.”
- Work out the information ratio on both an ex post and an ex ante basis, explain what it means, and contrast it with the Sharpe ratio
“The information ratio divides active return by active risk.”
- Contrast factor-tilted index strategies with plain market-cap-weighted indexing
“The trap is calling factor strategies purely passive: choosing the factor, its definition and the rebalancing rule are active decisions, so the relevant risk is tracking error against a broad cap-weighted benchmark.”
- Contrast how risk is defined when allocating on a goals-based, liability-relative or asset-only basis
“For asset-only allocation, risk is volatility of portfolio return, or tracking error against a policy benchmark, sometimes supplemented by downside measures such as conditional value at risk.”
See also
Active return · Standard deviation
Practise it
Practise active risk until it is automatic: questions that explain every wrong option.
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