On the Optimal Mix of Active and Passive Investments

Abstract

A modified version of the appraisal ratio developed by Treynor and Black in 1973 identifies a unique mix of active and passive investments that is optimal for every investor, regardless of his or her preferences for risk and return. This result suggests that financial advisors can consider recommending specific dollar amounts for clients to allocate to active investment strategies, rather than simply recommending qualitative assessments regarding such opportunities. The article identifies corresponding implications for services that provide estimates of analytic measures that are used to evaluate active investments, as well as for institutions that manage active portfolios on behalf of individuals.