This is powerful information for the risk manager. Now, based on the specific information gleaned from conversations with the portfolio manager, the risk manager can more effectively monitor changes and risk levels in the portfolio. RISK BUDGET Understanding the nature and the sources of risks taken in the investment program is essential. Ultimately, intelligent placing of portfolio exposures will result in a more consistent alpha generation process. The risk budget (Table 15.3) is the diagnostic tool of risk decomposition: Its aim is to identify the sources and magnitudes of risk taken in the aggregate portfolio. Before plan sponsors prescribe changes to the composition or implementation of the investment program, they can make use of the risk budget to obtain a diagnosis of the situation. Suppose that when risk targets are set, it is with the paradigm in mind that the bulk of active plan risk should come from security selection rather than other deviations from the given benchmark. Security selection resulting from in-depth investment research is typically considered an area where active managers can add value. If we think of risk management as resource allocation in a scarce or budgeted environment, the risk budget will hopefully streamline that process by giving the sponsors signals about realized risks. If these signals are not congruent to expectations, this tool allows tracing the misalignment to three areas: asset allocation, beta or market leverage, and individual security selection. Furthermore, the risk budgeting tool provides relevant information at the manager, asset class, and fund level. At the asset class or manager level, plan sponsors will have a target allocation set as a percentage of the total fund. To the extent managers are over/underfunded an asset allocation risk is generated: The fund is over/underexposed to this asset class. This can occur, for example, as a result of market drifts between asset classes. In the example summarized in Table 15.3, the U.S. equity asset class is above target weight, and this accounts for 2.3 percent of the total plan risk. U.S. equities have outperformed their international counterpart, which has created a 1.6 percent overweight in U.S. equities. In order to correct this situation, plan sponsors often employ completion strategies. Completion managers will utilize futures, long and short, to bring the asset class over/underweights back to strategic targets. Completion strategies are discussed further in Chapter 25. Completion strategies remove the need to frequently move capital in and out of active strategies, thus alleviating undue transaction costs for the aggregate portfolio. An additional source of risk can come from the sensitivity of a manager's portfolio to the swings of its underlying benchmark. The statistical measure of this sensitivity is known as beta. When beta is greater than 1.0, the portfolio exhibits a form of market leverage: It can be expected to outperform in up markets and un-derperform in down markets. In Table 15.3, the international equity asset class has a beta of 0.98. This implies that the intended asset allocation is somewhat distorted. The low beta can translate into the fund being underexposed to international equity. In this particular case, one of the managers in the international roster is systematically tilted toward the value side of the benchmark, investing in