Fundamental law of active management
The result that expected information ratio ≈ transfer coefficient × information coefficient × √breadth: skill, times how many independent bets, scaled by how fully they reach the portfolio.
Where you will meet it
Fundamental law of active management appears in 2 learning outcomes on the CFA syllabus. A few of them:
- Set out and explain the fundamental law of active management for portfolios and each of its terms: breadth, the information coefficient, the transfer coefficient, and active risk (aggressiveness)
“The fundamental law links expected active return to four inputs.”
- Set out where active management's fundamental law is useful in practice and where it falls short
“The fundamental law is a powerful way to think about where active return comes from, to compare strategies and to quantify the cost of constraints, but it is hard to apply precisely.”
See also
Breadth · Information coefficient · Information ratio · Transfer coefficient
Practise it
Practise fundamental law of active management until it is automatic: questions that explain every wrong option.
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