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1 The Active Manager Investment Process and Cross-Sectional Volatility (CrossVol™) Paul Bouchey, Director of Research, Parametric Portfolio Associates.

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Presentation on theme: "1 The Active Manager Investment Process and Cross-Sectional Volatility (CrossVol™) Paul Bouchey, Director of Research, Parametric Portfolio Associates."— Presentation transcript:

1 1 The Active Manager Investment Process and Cross-Sectional Volatility (CrossVol™) Paul Bouchey, Director of Research, Parametric Portfolio Associates November 2010

2 2 Important information Copyright© Russell Investments 2010. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form other than as delivered in this presentation format, without the prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty. Russell Investments, a Washington, USA corporation, operates through subsidiaries worldwide, and is a subsidiary of The Northwestern Mutual Life Insurance Company. Russell Investments is the owner of the trademarks, service marks, and copyrights related to the Russell Indexes. The Russell logo is a trademark and service mark of Russell Investments. Indexes and/or benchmarks are unmanaged and are provided for general comparison purposes only. They cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Unless otherwise noted, source for the data in this presentation is Russell Investments. Index benchmark return information is provided by vendors and although deemed reliable, is not guaranteed by Russell Investments or its affiliates. The information, analyses and opinions set forth herein are intended to serve as general information only and should not be relied upon by any individual or entity as advice or recommendations specific to that individual or entity. Anyone using this material should consult with their own attorney, accountant, financial or tax adviser or consultants on whom they rely for investment advice specific to their own circumstances. This material is not an offer, solicitation or recommendation to purchase any security. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. First used September 2010. CORP-6271

3 3 The fundamental law of active management  Since 2001, academics and practitioners have published on how to measure breadth  Cross sectional volatility of market constituent returns (CrossVol) is a recognized measure of Breadth  Studies look at use of CrossVol in  Active v. Passive decision at the AA level  Managing active exposures  Evaluating/explaining active management performance Active contribution = skill (IC) times breadth of opportunity set

4 4 CrossVol calculation We measure and report the cross-sectional volatility of each market as follows: Where w i = the beginning of period, float-adjusted capitalization weight of stock i r i = the total return of stock i for the period R = the published return of the relevant Russell index for the period

5 5 CrossVol as a measure of overall market volatility Source: Parametric and Russell Investments. As of July 30, 2010 Monthly CrossVol Russell Global Index July 1996 – July 2010

6 6 CrossVol as a measure of sector volatility Source: Parametric and Russell Investments. As of July 30, 2010 Monthly CrossVol Russell Global Index –Technology and Financial Sectors July 1996 – July 2010

7 CrossVol as a measure of sector volatility 7 Source: Parametric and Russell Investments. As of June 30, 2010 CrossVol for Global Sectors April 2010 Historical CrossVol Ranges (5 th, 50 th and 95 th Percentiles) Based on Monthly CrossVol Levels June 1996 – June 2010

8 8 CrossVol and the dispersion of active manager returns – U.S. Large Cap Source: Parametric and Russell Investments. As of December 31, 2009 Monthly CrossVol and Manager Dispersion: U.S. Large Cap Market-Oriented Managers and the Russell 1000® Index December 31, 2003 – December 31, 2009

9 9 CrossVol and the dispersion of active manager returns – U.S. Small Cap Source: Parametric and Russell Investments. As of December 31, 2009 Monthly CrossVol and Manager Dispersion: U.S. Small Cap Market-Oriented Managers and the Russell 2000® Index December 31, 2003 – December 31, 2009

10 10 CrossVol and the dispersion of active manager returns – Global Equity Source: Parametric and Russell Investments. As of December 31, 2009 Monthly CrossVol and Manager Dispersion: Global Managers and the Russell Global Index December 31, 2004 – December 31, 2009

11 11 Regression Results CrossVol UniverseCrossVol Index BaseR-SqrdCoeffT-Stat US Large Cap Market OrientedRussell 1000 ® 0.880.6123.3 US Large Cap ValueRussell 1000 ® Value0.870.6521.7 US Large Cap GrowthRussell 1000 ® Growth0.750.7314.8 US Small Cap Market OrientedRussell 2000 ® 0.760.5615.4 US Small Cap ValueRussell 2000 ® Value0.810.6117.7 US Small Cap GrowthRussell 2000 ® Growth0.580.4710.1 Global EquityRussell Global0.840.8818.2 Non-US EquityRussell Developed ex-US Large Cap0.830.7417.5 Source: Parametric and Russell Investments. As of December 31, 2009

12 12 Applications of CrossVol  CrossVol can inform the active vs passive decision in the asset allocation decision.  CrossVol contains important information for managers with tight risk-controls.  Conversely, for managers with broader constraints or for absolute return strategies, CrossVol can be an indicator of where the best potential for outperformance is located in the market around the globe.  CrossVol can contribute important information to aid in the ex- post performance review process and for the evaluation of value-added from active management.


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