point remains the same: As long as the expected information ratios for each strategy are positive and uncorrelated, investors achieve a higher information ratio by combining strategies rather than relying on either strategy exclusively. So far, we have focused on the split between structured and active equity products, without discussing passive management. The reason is that, in active risk budgeting, passive management is both a risk-free and return-free strategy, while we have been focused on the allocation of active risk between the two active return-generating (i.e., risk-taking) strategies. How does passive management fit into the mix? The risk-free nature of passive management means that investors can use it to dampen the total active risk of their equity portfolios. As discussed in the preceding chapter, the first step is to decide on an appropriate level of total active risk (expressed in tracking error terms), and then to blend the optimal portfolio of active strategies with passive management to hit this target. For example, suppose an investor decides that the tracking error target for a domestic equity program should be 200 basis points. Suppose further that the investor estimates that the portfolio of traditional managers has a tracking error of 400 basis points (as shown earlier) and an information ratio of 0.60. If the investor allocates 50 percent of the total portfolio to a passive manager and 50 percent to the portfolio of traditional managers, the combined tracking error would hit its target of 200 basis points. Under our assumptions, the expected information ratio for the total domestic equity portfolio would be 0.60. This, in essence, is the barbell strategy. With a spectrum strategy, however, investors can do better. In Table 14.5, a 70/30 mix of structured and traditional managers achieves the highest information ratio (0.87). However, the tracking error of this mix is 160 basis points, which is less than the target of 200 basis points. Assuming the investor can't lever the optimal information ratio portfolio, the next best solution is to pick the mix in Table 14.5 that has a tracking error closest to the target. This portfolio has roughly 55 percent invested in structured strategies and the remaining 45 percent invested with traditional managers. The new information ratio of 0.81 is almost 7 percent lower than the optimal information ratio. This shortfall amounts to about 12 basis points in expected excess return,11 which equals the efficiency cost of the no-leverage constraint. Relative to the barbell strategy, however, this new mix represents a 35 percent improvement in efficiency (i.e., 0.81 versus 0.60), and an improvement in expected excess return of 42 basis points. Importantly, the source of this efficiency gain is moving from passive to structured management. In fact, in this example, for any tracking error target above 160 basis points, investors should have no passive exposure, and should instead allocate all of their equity assets to the structured and traditional programs. Next, let's look at an active risk target that is below 160 basis points. Suppose the targeted tracking error is 100 basis points for the total U.S. equity portfolio. We know from Table 14.5 that a mix of 70 percent invested in structured equity and 30 "Or 200 bps times (0.87 - 0.81).