Decomposing the Impact of Portfolio Constraints, August 2009

9 Pages Posted: 20 Nov 2009

See all articles by Jennifer Bender

Jennifer Bender

State Street Global Advisors

Jyh-Huei Lee

MSCI Inc.

Dan Stefek

MSCI Inc.

Date Written: August 19, 2009

Abstract

This paper analyzes the impact of constraints on portfolio return and risk, extending the insights of previous research in this area. We show that constraints move a manager’s portfolio away from the optimal unconstrained portfolio in two ways. First, they may rein in or increase the risk of the portfolio without impairing its information ratio. Second, they may force the portfolio to take unwanted bets that incur risk but yield no return. As a result, a constrained portfolio consists of positions that are aligned with the manager’s alphas and positions that are orthogonal to the alphas but are adopted to satisfy the constraints. We illustrate how to measure the risk and return arising from each of these sources and how to drill down to examine the contributions of individual constraints.

Keywords: decomposing impact portfolio constraints return risk constrained alphas positions orthogonal measure

Suggested Citation

Bender, Jennifer and Lee, Jyh-Huei and Stefek, Dan, Decomposing the Impact of Portfolio Constraints, August 2009 (August 19, 2009). MSCI Barra Research Paper No. 2009-30, Available at SSRN: https://ssrn.com/abstract=1508733 or http://dx.doi.org/10.2139/ssrn.1508733

Jennifer Bender (Contact Author)

State Street Global Advisors ( email )

1 Lincoln Street
28th Floor
Boston, MA 02111
United States

Jyh-Huei Lee

MSCI Inc. ( email )

88 Pine Street
2nd Floor
New York, NY 10005
United States

Dan Stefek

MSCI Inc. ( email )

88 Pine Street
2nd Floor
New York, NY 10005
United States

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