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Residual Risk 257
FIGURE 9 3
Sacrifice in Utility from Using Less-Skillful Manager
with portfolio Hop with utility of 0.417 percent, portfolio IHl offers
the investor a gain in utility of 0.833 percentage point (1.250-
0.417).
However, as Figure 9-5 indicates, even portfolio IHl is
suboptimal for the investor with 0.15 residual risk aversion and access
to a manager with IRof an 1.0. This investor will maximize util-
ity by holding the original portfolio Hl (utility of 1.667 percent).
Permitting portfolios beyond
provides a gain in utility of 0.417 percentage point (1.667-
1.250).
the 2 percent curtain, in this case H,,
SOME IMPLICATIONS
We have raised 2 the percent curtain to view some of the opportunities
that lie beyond it. Not surprisingly, the landscape beyond curtain the
abides by the same as laws the landscape within: Greater excess return
comes at a cost of greater residual risk. We have found that the slope of
the ascent wildepend upon the manager’s skill, as measured by IR: