Fundamental law of active management

What it means

Expected active return is a function of skill, the number of independent decisions taken, and how fully those decisions are expressed in the portfolio.

The exam angle

Breadth must be independent bets. Applying the same macro view to two hundred stocks is one decision, not two hundred.

Where it appears in the syllabus

• Portfolio ConstructionCFA Level II · exam weight 10–15% · Active management, ETFs, multifactor models, market risk, backtesting.
• Portfolio Management pathwayCFA Level III · exam weight 30–35% · Active equity, yield-curve and credit strategy, LDI, trade execution.

Related terms

• Active shareThe proportion of a portfolio’s holdings that differs from its benchmark, from 0% for an index fund to 100% for no…
• Arbitrage pricing theoryA model deriving expected returns from exposures to multiple systematic factors, assuming no arbitrage rather than a…
• Factor investingBuilding portfolios around systematic return drivers — value, size, momentum, quality, low volatility — rather than…
• Multifactor modelA model explaining returns by exposure to several systematic factors rather than to the market alone.
• Style driftA manager gradually moving away from the strategy the mandate describes.
• Derivatives overlayAdjusting a portfolio’s exposures with derivatives while leaving the underlying holdings untouched.