Dynamic Tracking Error and the Total Portfolio Approach

Strategic Asset Allocation and the Total Portfolio Approach differ in one thing: the tracking error the board grants the chief investment officer. The board's first decision should be the drawdown it can tolerate; the benchmark and tracking error budget follow. The value comes from spending that budget dynamically, adding active risk when the reward is high and shedding it as the fund nears its limit. Managed this way, a fund would have compounded about two percentage points a year faster at the same drawdown, with no security selection. What matters is dynamic versus static tracking error, not the label.