Manager skill and portfolio size with respect to a benchmark

Andrei Bolshakov and Ludwig B. Chincarini

European Financial Management, 2020, vol. 26, issue 1, 176-197

Abstract: Investment managers often manage a portfolio with respect to a benchmark. Typically, they use a mean‐variance optimization framework to maximize the information ratio of their portfolio. We develop an unconventional approach to this question. Given a set of assumptions, we ask what optimal percentage of the benchmark stocks the portfolio manager should select. This optimal portfolio depends on Fisher's and Wallenius's noncentral hypergeometric distributions. We find that the optimal selectivity of a benchmark universe varies from 50% to 80%. These results are provocative, given that many enhanced index portfolio managers select a low percentage of the benchmark universe.

Date: 2020
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https://doi.org/10.1111/eufm.12210

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Persistent link: https://EconPapers.repec.org/RePEc:bla:eufman:v:26:y:2020:i:1:p:176-197

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