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Subject 4. Applications of the Fundamental Law PDF Download
Three specific applications of active portfolio management are discussed in the reading.

Global Equity Strategy

The fundamental law is proven to be quite accurate in calculating the expected active return and information ratio.

The information ratio of an unconstrained portfolio will remain the same if the level of active risk increases. The expected active return will increase proportionally. However, the IR for a constrained portfolio generally decreases with the aggressiveness of the strategy.

Fixed Income Strategies

The two examples illustrate how the information coefficient measures the strength of the return-forecasting process. They also illustrate that active managers can increase the breadth by rebalancing more frequently, but only if active returns of these assets are truly uncorrelated over time. Furthermore, to increase the information ratio, one would have to assume that the information coefficient remains the same and there are no constraints to fully implementing the active management decisions.

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