developed, it is commonplace to see the largest plans investing as much as 5 percent to high-yield bonds, 5 percent to publicly traded real estate, 5 to 10 percent to small-capitalization stocks, and 5 percent to emerging-market equities-all classic lower-capitalization, lower-capacity, and high-transaction-cost asset classes. In Chapter 21, we discussed the importance of investment managers capping product capacity in these asset classes in order to maintain product quality. Because of the low capacity of high-quality products, a $10 billion plan could need two or three high-yield managers, two or three real estate investment trust (REIT) managers, five to seven small-capitalization managers, and two or three emerging-market equity managers in order to be fully invested in the asset class. The tension between the need to implement an asset allocation and the lack of high-quality supply to implement the asset allocation creates significant manager selection work. Many times, this supply/demand imbalance causes the number of managers in the largest plans to be significant. As the number of managers in the plan increases, so does the diversification of active management risk. While on the surface this sounds attractive, in the largest plans with significant numbers of active managers across asset classes the benefit of diversification must be balanced against the risk of hiring lower-quality managers as well as the increased costs associated with higher numbers of active managers. As discussed in Chapters 12 and 13, investors should construct portfolios so that the correlation of excess returns among managers works to reduce active risk to acceptable levels. However, in the largest plans where the number of managers is highest due to the aforementioned reasons, the marginal opportunities to reduce risk are dampened by the sheer number of managers and the ensuing diversification. Outlined in Figure 22.1 is an example of how large plans get marginally less diversification benefit (i.e., lower tracking error) from adding new managers to the plan. As discussed in Chapter 13, investors overseeing the largest plans must be vigilant in their demand for and monitoring of risk-budgeted tracking error. Active 350 300 & 250 ■a I 200 i 150 Lac: | 100 50 0 4 7 9 10 22 33 44 55 Total Number of Active Managers FIGURE 22.1 Total Fund Tracking Error