68 The Basics of financial economeTrics
would have outperformed the benchmark by a wide margin (1.05%). In
contrast, if the FRC 2000 Index is used as the benchmark, the manager
would have underperformed by 0.45%.
One interpretation of the results of a Sharpe benchmark that has arisen
in practice is that if the R^2 is low, this is an indication that the portfolio
is actively managed because it is not associated with any particular style.
However, this need not be the case as pointed out by Dor and Jaganna-
than.^17 One of the reasons could be due to inadequate asset class indexes.
Dor and Jagannathan illustrate the importance of including adequate asset
class indexes using the Putnam Utilities Growth and Income, a mutual fund.
Table 3.7 reports the Sharpe benchmark based on regression analysis of
returns from January 1992 through August 2001.
(^17) Arik Ben Dor and Ravi Jagannathan, “Style Analysis: Asset Allocation and Per-
formance Evaluation,” in The Handbook of Equity Style Management, 3rd ed., ed.
T. Daniel Coggin and Frank J. Fabozzi (Hoboken, NJ: John Wiley & Sons, 2003).
TAbLE 3.7 Sharpe Benchmark for Putnam Utilities Growth and Income, January
1992 through August 2001
Asset Class Basic Model Extended Model
Bills 0 3.4%
Treasury 1–10 yrs 11.9% 0
Treasury 10+ yrs 20.5% 0
Corporate Bonds 0 0
Large-Cap Value 56.8% 14.7%
Large-Cap Growth 0 0
Small-Cap Value 0 4.4%
Small-Cap Growth 0 0
Developed Countries 0 0
Japan 0 0
Emerging Markets 0 0
Foreign Bonds 10.8% 10.6%
Dow Jones Utilities — 44.6%
Dow Jones Communications — 16.5%
Dow Jones Energy — 5.9%
R^2 0.669 0.929
Source: Exhibit 1.10 in Arik Ben Dor and Ravi Jagannathan, “Style Analysis: Asset
Allocation and Performance Evaluation,” in The Handbook of Equity Style Manage-
ment, 3rd ed., ed. T. Daniel Coggin and Frank J. Fabozzi (Hoboken, NJ: John Wiley
& Sons, 2003).