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

2. Important information
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First used September 2010.
CORP-6271 2

3. The fundamental law of active management
Active contribution = skill (IC) times breadth of opportunity set
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 3

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

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

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

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

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

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

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

11. Regression Results CrossVol Universe CrossVol Index Base R-Sqrd Coeff
CrossVol
Universe
CrossVol Index Base
R-Sqrd
Coeff
T-Stat
US Large Cap Market Oriented
Russell 1000®
0.88
0.61
23.3
US Large Cap Value
Russell 1000® Value
0.87
0.65
21.7
US Large Cap Growth
Russell 1000® Growth
0.75
0.73
14.8
US Small Cap Market Oriented
Russell 2000®
0.76
0.56
15.4
US Small Cap Value
Russell 2000® Value
0.81
17.7
US Small Cap Growth
Russell 2000® Growth
0.58
0.47
10.1
Global Equity
Russell Global
0.84
18.2
Non-US Equity
Russell Developed ex-US Large Cap
0.83
0.74
17.5
Source: Parametric and Russell Investments. As of December 31, 2009 11

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. 12