A framework for active-passive allocations

Making the implicit explicit – a framework for the active-passive decision – Vanguard Research

How should an investor allocate across active and passive investments? It’s a challenging decision with many components. In the absence of a structured decision-making process, investors are left making arbitrary decisions based on implicit assumptions.

In this paper, Vanguard provides a quantitative framework for active-passive decision-making and aims to shed light on those implicit assumptions by highlighting the explicit attributes affecting the process. It employs a model using four key variables — gross alpha expectation, cost, active risk, and active risk tolerance — to establish active and passive investment allocation targets for a range of investor types.

Indexing is a valuable starting point for all investors, and many may index their entire portfolio. But this analysis shows that for those who are comfortable with the characteristics of active investments, an allocation to active may also be a viable solution.

— Daniel W. Wallick; Brian R. Wimmer, CFA; Christos Tasopoulos; James Balsamo, CFA; Joshua M. Hirt

 

(Click on the cover page image for the full document).

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