TY - JOUR T1 - 130/30: <em>By How Much Will the Information Ratio</em> <br/> <em>Improve?</em> JF - The Journal of Portfolio Management SP - 62 LP - 69 DO - 10.3905/jpm.2011.37.3.062 VL - 37 IS - 3 AU - Ramon Tol AU - Christiaan Wanningen Y1 - 2011/04/30 UR - https://pm-research.com/content/37/3/62.abstract N2 - In this article,Tol andWanningen aim to quantify empirically how much the information ratio may improve for a 130/30 extension strategy versus a long-only strategy. The authors collected 42 estimates of transfer coefficients for U.S. large-cap benchmarked 130/30 products and their equivalent long-only products. According to the fundamental law of active management, an improvement in the transfer coefficient directly translates into an improvement in the information ratio, assuming a skillful manager. Their results show an average increase in the transfer coefficient of between 40% and 50%, depending on the long-only tracking error. This finding implies a 40%–50% increase in the information ratio. Furthermore, the authors reason that the increase in the transfer coefficient depends on the tracking error of the long-only strategy. Tol and Wanningen’s empirical results show that to move from a long-only to a 130/30 strategy would result in an average increase in the transfer coefficient of 42% for a strategy with an ex ante tracking error of between 0% and 2%; 48% for a strategy with an ex ante tracking error of between 2% and 3%; and 29% for strategies with a tracking error higher than 3%. This shows that the sweet spot (i.e., the highest increase in transfer coefficient by moving from long-only to 130/30) occurs in the 2%–3% long-only tracking error range. The study reveals theoretically overestimated information ratio improvements for more than 40% of the product pairs.TOPICS: Information providers/credit ratings, statistical methods, portfolio construction ER -