First Quarter 2014 Russell Canadian Active Manager Report Highlights
- Only 31% of large cap managers beat the benchmark
- Small cap managers lead large cap for the 5th consecutive quarter
- Environment improving slightly thus far in the second quarter
TORONTO, May 1, 2014 /CNW/ - After a strong year for active managers in 2013, less than a third (31%) of large cap managers were able to beat the S&P/TSX Composite Index in the first quarter of 2014, down from 86% in the previous quarter. The median manager return in the quarter was 5.5%, behind the S&P/TSX Composite Index return of 6.1%.
"We saw the trend reverse this quarter after seeing a string of five consecutive quarters of favourable active management environments and a 2013 that was overall the best year for active managers since 2001," noted Kathleen Wylie, Head, Canadian Equity Research at Russell Investments. "There will always be periods in which active managers struggle, but in the long run they can add value. Over the last 10 years, in fact, an average of 55% of large cap managers have beaten the benchmark with the top quartile manager ahead of the benchmark by nearly 150 basis points per quarter on average."
During the first quarter, five of 10 sectors beat the benchmark, but investment managers were only favourably positioned in four. The top three performing sectors in Canada were Healthcare, Materials and Energy and Canadian large cap managers were underweight all three at the start of the quarter. The strength in Healthcare was driven by Valeant Pharmaceuticals, up nearly 17% but only held by 37% of large cap managers. The largest negative contributing stock in the quarter was Teck Resources, down nearly 14% and held by 58% of large cap managers. Large cap managers had their largest overweight to Consumer Discretionary, Information Technology, and Industrials, three underperforming sectors.
Within Materials, gold stocks rose 12% in the quarter. "The weight of gold stocks in the Index was only 5% at the start of the first quarter, but active managers were still 2% underweight so that hurt their benchmark relative performance to some extent," explains Wylie. "The good news is that gold stock performance is having less of an impact on benchmark relative performance now than in the past when gold peaked at 14% of the Index and large cap managers were 6% underweight on average."
All Styles Lagged in the Quarter
Value managers fared slightly better than growth and dividend managers in the first quarter, with 33% beating the benchmark. That compares to only 25% of growth and 15% of dividend managers beating the benchmark. The median value manager return was 5.5%, just slightly ahead of the median growth manager return of 5.4%. The median dividend manager return was 4.3%. Dividend managers struggled the most due in part to their overweight to Telecom stocks, which underperformed. They also have the biggest underweight to gold stocks at nearly 4% compared to 1.5% for growth and 2% for value managers. And they have a larger weight in Financials compared to the other styles.
"It is interesting to note that dividend managers on average have moved to an underweight position in Financials. Part of that stems from the fact that the Financials sector has now grown to over 35% of the Index," says Wylie. "The Canadian market has a tendency to go from one concentration issue to another, which can present challenges for investment managers. Nortel was the concentration issue in 2000, then resources grew to over 50% of the Index weight in 2008, then gold stocks peaked at 14% in 2011. And now Financials is the new concentration issue."
Small Cap Managers Ahead of Large Cap
For the fifth consecutive quarter, small cap managers in Canada have beaten their large cap counterparts. In the first quarter, the median small cap return was 7.9% compared to the median large cap return of 5.5%. Small cap manager performance matched the S&P/TSX Small Cap Index return of 7.9%, ahead of the S&P/TSX Composite return of 6.1%. In the first quarter, 46% of small cap managers beat their benchmark, down from 92% in the fourth quarter.
Sector breadth in the small cap space was narrower, with only four sectors beating the benchmark and small cap managers on average underweight the outperforming sectors, which were Energy, Materials, Healthcare and Utilities. "Small cap managers who were overweight Energy and underweight Financials did best in the quarter but it looks like stock selection rather than sector positioning was key for most managers that outperformed," states Wylie.
Although small cap manager returns can be volatile, they have added significant value against the benchmark and relative to large cap managers. Over the last 10 years, the median small cap manager was ahead of the benchmark by roughly 160 basis points on average per quarter and beat the median large cap manager by nearly 65 basis points on average per quarter.
Environment Looking Better So Far in the Second Quarter
Although it is still early, the environment for active managers appears to be more favourable so far in the second quarter. Sector breadth is worse, with only three of 10 sectors ahead of the benchmark, but large cap managers are favourably positioned in six of them. Although Energy is the top-performing sector and large cap managers on average are underweight, they are benefitting from their overweight to Information Technology and Industrials which are both outperforming. Large cap managers have their largest underweights to the Materials and Financials sectors, which is helping their benchmark relative performance since both sectors are underperforming.
"It's not clear which style is ahead so far this quarter," highlights Wylie. Growth managers are likely benefiting from their larger overweight to Information Technology and their underweight to Telecom while value managers are likely being helped by a larger overweight on average to Industrials and a large underweight to Financials. Dividend managers would benefit most from the decline in gold stocks so far this quarter since they have the largest underweight. "It's too early to tell because the environment is changing every day," states Wylie, "so it's best to just stay the course and maintain a diversified portfolio."
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