Alpha and signal research

The fundamental law of active management

Trades signal quality against how many independent bets you can place with it.

IR≈IC×BR\mathrm{IR} \approx \mathrm{IC} \times \sqrt{\mathrm{BR}}

Where

IC\mathrm{IC}
Cross-sectional correlation of forecast with forward return. 0.030.03 is genuinely good.
BR\mathrm{BR}
Independent bets a year — not positions.

Assumptions

  • Breadth must be genuinely independent. Five hundred names driven by one sector tilt is one bet.

Sanity check. Doubling the information ratio takes four times the breadth, since it enters as a square root.

Where this is taught