FRM Part II · FRM Exam Part II · Portfolio Construction

A long-only equity fund adds a constraint that no stock may have a negative weight. Relative to the unconstrained long-short solution for the same benchmark-relative objective, which statement best describes the effect of the long-only constraint on the fund's ability to exploit information?

The long-only constraint lowers the transfer coefficient because negative views, especially on stocks with small benchmark weights, cannot be fully expressed through underweights. As the realized information ratio equals the transfer coefficient times the unconstrained information ratio, performance potential falls.

1. AIt reduces the transfer coefficient, because negative views on small-cap stocks cannot be fully expressed, lowering realized information ratio versus the unconstrained idealCorrect
2. BIt increases the transfer coefficient, because constraints always improve the match between signals and positions
3. CIt has no effect, because the information ratio does not depend on the weights actually held
4. DIt raises the fundamental law's breadth, because fewer positions raises the number of independent bets