170 Optimizing Optimization
specified in the beginning is the asset allocation that one ends up with. This is the
most important decision made in that it accounts for 80% or more of the future
return of the portfolio. The second consideration is to hire those managers who
can add the greatest value to the portfolio. This must take into consideration
each manager’s style blend in order to not corrupt the desired asset allocation.
Third, use passive indexes to fill out the asset allocation in areas where the active
managers do not add value.
For a manager to come into solution, the R 2 must be 0.70 or greater, the
upside potential ratio must be among the highest, and the DTR α must be in
the top three. In the portfolios case, three active managers added value to the
portfolio and passive indexes were used to fulfill the asset allocation. This is a
quantitative way of reducing costs while adding value as measured by a man-
ager’s ability to beat his or her style blend.