The decomposition of the total active performance into true and misfit components is useful for optimization. The objective is maximize the total active return for a given level of total active risk, while still allowing for an optimal amount of misfit risk. Note that misfit risk is not optimized at zero because a manager may be able to generate a level of true active return for some level of misfit risk. In other words, if you let the manager specialize in the style they are familiar with, the manager is more likely to generate excess returns relative to their normal portfolio. |
