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The Active Manager Investment Process and Cross-Sectional Volatility (CrossVol™)
Paul Bouchey, Director of Research, Parametric Portfolio Associates
November 2010
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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.
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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
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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
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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
i
iix Rrw 2
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CrossVol as a measure of overall market volatility
Source: Parametric and Russell Investments. As of July 30, 2010
Monthly CrossVolRussell Global IndexJuly 1996 – July 2010
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CrossVol as a measure of sector volatility
Source: Parametric and Russell Investments. As of July 30, 2010
Monthly CrossVolRussell Global Index –Technology and Financial Sectors
July 1996 – July 2010
CrossVol as a measure of sector volatility
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Source: Parametric and Russell Investments. As of June 30, 2010
CrossVol for Global Sectors April 2010Historical CrossVol Ranges (5th, 50th and 95th Percentiles) Based on Monthly CrossVol Levels
June 1996 – June 2010
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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
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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
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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
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Regression Results
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 0.61 17.7
US Small Cap Growth Russell 2000® Growth 0.58 0.47 10.1
Global Equity Russell Global 0.84 0.88 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
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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.
