for active risk must be weighed against several factors, including its ability to sustain losses in excess of its strategic benchmark. Just as a household needs to impose a budget that constrains spending to levels not exceeding income earned, so does a plan sponsor need to budget a realistic level of active risk commensurate with its ability to tolerate persistent active manager underperformance. Once a level of active risk at each asset class and at the plan level has been agreed upon and managers have been selected to implement their strategies, it is then up to the risk oversight team to ensure effective implementation of the risk program. Effectiveness begins with understanding both individual manager and asset class level active risk characteristics and setting targets commensurate with expectations. Implementation of a risk program at the total fund can be a simple yet effective way of determining the efficacy of the investment program. The tools and techniques described in this chapter will provide insights into how a risk program can be executed. Clearly, the goal of an active investment manager is to outperform a benchmark. However, we suggest that there is an additional dimension that ought to be used to measure investment manager skill. Investment managers should also be managing to a targeted level of risk, and in particular, managing the range within which the tracking error of their portfolio fluctuates.1 It is our belief that most investment managers look to produce consistent, risk-adjusted performance relative to a benchmark. What this suggests is that investment managers must first develop the skills necessary to understand and manage their tracking error. For example, just because a domestic equity manager is able to beat the Russell 3000 index, we shouldn't automatically assume that a plan sponsor should want to continue to retain the manager's services. Suppose the manager's outperformance is being derived with unacceptably high levels of tracking error, thus degrading the manager's realized information ratio. Clearly, not knowing how much risk is being taken at the manager level unduly handicaps a plan sponsor's ability to make sound investment decisions. These manager-specific issues can also exaggerate the amount and quality of risk2 being taken at the total plan level. An effective risk monitoring program is simple to put in place, however, and empowers the plan sponsor to evaluate not only the level of active risk at the manager and plan levels, but also the sources and the quality of active risk being generated in the investment program. Fortunately, for plan sponsors there are alternatives as to how their investment plans can be implemented. First and foremost, a plan sponsor can choose to implement a strategic asset allocation through low-cost passive index alternatives that attempt to replicate the return and risk characteristics of an asset class. In doing so, plan sponsors would be making a determination that active managers do not have the skills required to beat the relevant asset class benchmark by enough to cover their fees and transaction costs (implicit and explicit) plus the costs associated with ]For more information, please see "The Green Zone . . . Assessing the Quality of Returns" (March 2000) by Robert Litterman et al. of Goldman Sachs & Co. 2We typically think of quality of risk as the percentage of active variance not explained via systematic factors, such as market, style, industry, or sector factors.