McGraw-Hill

300 Expandingopportunities
F I G U R E 11-8
Equitized versus S&P 500 Monthly Returns-June
1990-December 1992
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The value-added is the same as that achieved in the marketneutral
strategy, but the futures overlay "transports" the long-short
spread to the S&P 500 benchmark. In the same way, bond futures
can be used to transport the long-short value-added to a bond index,
and so forth.
Because the equitized strategy produces approximately an S&P
500 return when there is no performance.spread between the longs
and shorts, an appropriate benchmark for the strategy is the S&P 500
index. Figure 11-8 is a scatterplot of OUT live monthly equitized returns
versus the monthly returns of the S&P 500 index. As expected, the
strategy's returns are highly correlated with the stock market.
THEORETICAL TRACKING ERROR
In addition to return considerations, it is instructive to consider the
theoretical tracking error of long-short portfolios relative to their
benchmarks. Assume the standard deviation of the long portfolio's
alpha, or value-added, is 4 percent, and the short portfolio alpha's