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Total Portfolio Approach

Concept 3 of 6

Active-risk budget

The board sets how far the fund may stray from its cheap reference portfolio; management decides where to spend that allowance.

Why this matters to you

Choose your view in the header to see why this matters to you and to start at the right level.

In plain words

The board tells the investment team: you may run the fund differently from a cheap, simple default portfolio, but only this far. That allowance is the active-risk budget. The team then decides where to spend it, aiming for the ideas most likely to pay.

Sources: CFA Institute Research Foundation 2026, p. 29; CalPERS 2025, memo p. 2; A. Ang, M. Brandt, D. Denison for the Norwegian Ministry of Finance 2014, p. 9

Picture it

Start from the fund's reference portfolio, the cheap mix of index investments it could always hold instead. Every departure from it, such as buying property, hiring a stock-picker or leaning towards cheaper markets, makes the fund's result wander away from the reference portfolio's. Active risk measures how far that wandering typically goes in a year.

The budget caps the total, not each bet. Bets that tend to win and lose together use it up quickly, while unrelated bets partly offset each other, so the same budget stretches further.

Sources: A. Ang, M. Brandt, D. Denison for the Norwegian Ministry of Finance 2014, p. 9; CalPERS 2025, deck slides 7, 9; CalPERS Board 2025, slide 12; Meketa 2026, p. 1

Three bets, one budget

Illustrative numbers

The board sets a budget of 300bp of active risk a year (a basis point, bp, is a hundredth of a percentage point). The team proposes three positions with stand-alone active risk of 200bp, 150bp and 150bp. How much of the budget they use together depends on how they move in relation to each other.

Combined active risk of the three positions (illustrative)
How the bets moveCombined active riskInside the 300bp budget?
Unrelated: risks combine like the sides of a right-angled triangleabout 292bpYes, just
Partly related: a correlation of 0.5 between each pairabout 409bpNo
Always together: risks simply add up500bpNo, well over

Only the unrelated version fits. At an assumed information ratio of 0.2 (0.2bp of extra return for each 1bp of active risk), it would add about 58bp a year. The budget rewards bets that differ from each other, not just bets that are good.

Notes on the numbers

  1. 23bp, 10bp and 6bp, CalPERS hypothetical active risk per percentage point of the fund moved: Treasuries to global equities; equities and Treasuries to core infrastructure; listed equities to buyout: Hypothetical figures from a CalPERS board presentation.

How funds do it

CalPERS, a large US public pension fund, shows the budget at work. In November 2025 its board's Investment Committee replaced asset-class targets and ranges with two settings it owns: a simple reference portfolio of global equities and US Treasuries, and an active-risk limit of 400bp (as of 17 Nov 2025 · source), in force from July 2026.

Staff now decide every departure from the reference portfolio, weighing competing ideas in a total-fund committee, and the board must be told if they exceed their discretion. Private assets draw on the same budget as manager selection.

  • Not more freedom: the limit sits below what the old ranges allowed, about 450bp (as of 17 Nov 2025 · source). Staff were using about 230bp (as of 17 Nov 2025 · source) and expect to operate at 250–350bp (as of 17 Nov 2025 · source).
  • Fewer fences, not none: private-market sub-limits by strategy, geography and risk class went; delegated authority and single-manager concentration limits stayed.
  • Measured before the fact: risk models look through to the underlying assets, and the board's consultants review them.
  • Spent unevenly: in an illustrative staff estimate, real estate was 9.7% of assets but 21.9% of estimated active risk (as of Jun 2025 · reported · source)1.
  • A modest planned payoff: 0.2 × 300bp ≈ 60bp a year (as of Nov 2025 · source)2, an assumed information ratio (return per unit of active risk) times the risk used.
  • Budgets can shrink: NZ Super cut its budget in 2026 by an undisclosed amount, helping lower its expected return from 7.80% to 7.20% a year (as of Sep 2026 · source).

Sources: CalPERS 2025, p. 1; section “Active Risk Limit”; CalPERS 2025, minutes pp. 3–4; transcript pp. 42, 46, 51, 60; CalPERS 2025, pp. 3–4; CalPERS 2025, slides 14–15; Wilshire 2026, pp. 2–3; Wilshire 2025, pp. 1–3; Meketa 2026, pp. 1–2; CalPERS 2025, memo p. 2; deck slides 8 fn, 14; NZ Super Fund, FY2026 release

Notes on the numbers

  1. 9.7% of assets but 21.9% of estimated active risk, CalPERS staff estimate of real estate's share of assets and of estimated active risk: An illustrative staff estimate from a June 2025 board presentation; the slide does not date the underlying data. Not a measured result.
  2. 0.2 × 300bp ≈ 60bp a year, CalPERS planning assumption: about 300bp of active risk at an information ratio of 0.2: An assumed excess return over the reference portfolio used for planning, not a measured result and not a promised gain over the old approach.

Expert view and evidence

Formally, CalPERS defines active risk as all the risk from management decisions beyond the reference portfolio's passive share and bond indices. It is usually measured as tracking error, the annualised standard deviation of returns relative to that portfolio. The CFA Institute's 2026 practical guide puts the typical level at around 4%–5% a year (as of Jul 2026 · source).

The CFA Research Foundation's review sees risk budgets cascading from board to chief investment officer to portfolio managers, ideally as auditable, board-level guardrails with escalation when breached. A budget is also only as good as its anchor: Norway's reviewers, citing Roll (1992), note that a tracking-error limit around a poorly designed benchmark yields an inferior portfolio.

  • Variants: Norway's 2014 reviewers proposed lifting its fund's limit from 1.0% a year (as of Jan 2014 · source) to 1.75% a year (as of Jan 2014 · source), plus a cap on large one-year shortfalls, since tracking error treats gains and losses alike. Australia's Future Fund has no tracking-error budget and steers its equivalent equity exposure at 65, within a runway of 60–70 (as of Aug 2025 · source).
  • Caveats: smoothed valuations flatter private assets, with realised volatility of 9% vs 17% (as of Nov 2025; Feb 2026 · source) for private versus public equity; risk models carry their own error; and where the budget is spent matters as much as its size.
  • Evidence: the information ratios used for planning are staff assumptions, not measured results. No controlled study shows that the total portfolio approach (TPA) beats a traditional strategic asset allocation; the CFA Research Foundation's 2026 review finds the literature does not establish systematic outperformance.

Sources: CalPERS 2025, memo p. 2; slides 8 fn, 10 fn; CalPERS Board 2025, slide 12; CFA Institute Research & Policy Center 2026, p. 20; CFA Institute Research Foundation 2026, pp. 29, 39; A. Ang, M. Brandt, D. Denison for the Norwegian Ministry of Finance 2014, pp. 7, 108 fn. 57, 109–110; Future Fund Board of Guardians 2025, para 5.13; Bridgewater Daily Observations podcast 2024, Ch. 2–3; Wilshire 2025, p. 3; Wilshire 2026, p. 3

Common misunderstandings

“More active risk must make the whole fund riskier.”

In fact:

Not necessarily. A departure from the reference portfolio can also diversify the fund, so active risk can raise or lower total risk. CalPERS staff made this point to their board when they explained the budget.

Sources: CalPERS 2025, deck slide 7

“Swapping asset-class ranges for one budget gives the investment team more freedom.”

In fact:

Not at CalPERS. Its 400bp (as of 17 Nov 2025 · source) limit sits below what its old ranges implied, about 450bp (as of 17 Nov 2025 · source), and staff told the board the change needed no more discretion than they already had. What changed is the shape: one budget instead of many separate fences.

Sources: CalPERS 2025, section “Active Risk Limit”; CalPERS 2025, p. 3

“Private assets with calm valuations barely use the budget.”

In fact:

Calm prices often reflect infrequent appraisals, not low risk. CalPERS' consultant Wilshire cites realised volatility of 9% vs 17% (as of Nov 2025; Feb 2026 · source) for private versus public equity, which is why CalPERS estimates active risk before the fact with look-through models.

Sources: Wilshire 2025, p. 3; Wilshire 2026, p. 3

“A good team uses the whole budget.”

In fact:

A limit is a ceiling, not a target. CalPERS expects to operate at 250–350bp (as of 17 Nov 2025 · source), below its 400bp (as of 17 Nov 2025 · source) limit, and Norway's 2014 reviewers treated part of any limit as a prudent buffer.

Sources: CalPERS 2025, section “Active Risk Limit”; A. Ang, M. Brandt, D. Denison for the Norwegian Ministry of Finance 2014, pp. 10, 111

Check yourself

At CalPERS, which of these draws on the active-risk budget?

Related

Sources

  1. The Total Portfolio Approach (TPA): A Practical Guide for Navigating the Transition to TPA. CFA Institute Research & Policy Center (R. Urwin & G. Hayman), 2026.
  2. Total Portfolio Approach: A Critical Literature Review. CFA Institute Research Foundation (R. Elkamhi and J.S.H. Lee), 2026.
  3. Review of the Active Management of the Norwegian Government Pension Fund Global. A. Ang, M. Brandt, D. Denison for the Norwegian Ministry of Finance, 2014.
  4. Reference Portfolio. NZ Super Fund (Guardians), web page.
  5. Statement of Investment Policies. Future Fund Board of Guardians, 2025.
  6. Future Fund CIO Ben Samild on Building a Resilient Total Portfolio (transcript). Bridgewater Daily Observations podcast, 2024.
  7. ALM: First Reading of PERF Recommendations (staff deck). CalPERS (S. Gilmore, M. Nix, S. Terando), 2025.
  8. Asset Liability Management: First Reading of PERF Recommendations (agenda item 5c). CalPERS (M. Nix, S. Terando, S. Gilmore), 2025.
  9. ALM: PERF Recommendations (Investment Committee agenda item 5a). CalPERS, 2025.
  10. Wilshire opinion letter on ALM / TPA. Wilshire (S. Foresti, T. Toth), 2025.
  11. Board Education Day: TPA and transition considerations. CalPERS Board, 2025.
  12. Total Fund Policy Review: First Reading (Wilshire memo). Wilshire (T. Toth), 2026.
  13. Total Fund Policy Review: Second Reading (Meketa memo). Meketa (S. McCourt), 2026.
  14. Investment Committee transcript (TPA adoption meeting). CalPERS, 2025.
  15. ALM: Reference Portfolio Design and Active Risk Limits. CalPERS, 2025.