Making the Implicit Explicit: A Framework for the Active-Passive Decision

How should an investor allocate across active and passive investments? It’s a challenging decision with numerous components, and for many investors, indexing has become a valuable starting point that leads to choosing to index their entire portfolio. But our analysis shows that for those who are comfortable with the characteristics of active investments, an allocation to active can also be a viable solution. With this in mind, we provide a quantitative framework for active-passive decision-making looking at four key variables: gross alpha expectations, costs, active risk and risk tolerance.