25.17 percent with a lambda of 1, to 25.54 percent with a lambda of 10,
and to 25.81 percent with a lambda of 100. The corresponding t-statistics
on asset selection are 3.46, 3.75, and 3.87, respectively. One finds that asset
selection is enhanced with the use of R&D, and the use of higher lambda
values produces better asset selection and a reduction of risk indexes and
sector exposures. We report the total active return findings of the analysis of
lambda equaling 100 in Table 9.5, and the corresponding sector and risk in-
dex analysis in Tables 9.6 and 9.7, respectively. The technology and health
care industries have the highest R&D to market capitalization ratios among
the sectors, and the portfolio optimization results are consistent with the
sector data. R&D enhances portfolio returns and stockholder wealth, a re-
sult consistent with Guerard, Bean, and Stone (1990), but produces within
a more rigorous risk model.
We used the R&D variable as a quadratic term to enhance stockholder
returns in many Frank Russell universes during the 1990–2001 period. One
could have used dividend payments or capital expenditures as the quadratic
term. The use of dividend or capital expenditure quadratic variables lowers
total active returns and asset selection in the Russell 1000 universe relative to
the R&D quadratic term. (See Table 9.8.) Capital expenditures generate
higher asset selection in the Russell 2000 universe than R&D, but larger fac-
tor exposures, primarily due to earnings yield and growth indexes. R&D is a
better use of funds to enhance stockholder wealth than capital expenditures
and dividends in the Russell 1000. This is a particularly interesting result
given that companies historically spend on capital expenditures twice what
242 THE OPTIMIZATION OF EFFICIENT PORTFOLIOS
TABLE 9.5 Total Active Return of the CTEF Variable with R&D Quadratic
Variable, Lambda = 100. Attribution Report: Annualized Contributions to
Total Return
Contribution Risk Info
Source of Return (% Return) (% Std Dev) Ratio T-Stat
Risk Free 4.93
Total Benchmark 11.73 18.42
Expected Active 1.25
Market Timing 0.39 4.32 0.24 0.81
Risk Indexes 0.82 3.45 0.28 0.98
Sectors 2.00 6.08 0.33 1.15
Asset Selection 9.63 7.54 1.12 3.87
Total Exceptionally Active 12.84 11.44 1.09 3.76
Total Active 14.08 11.44 1.18 4.07
Total Managed 25.81 25.01