Q2 2024 Active Management Review: Momentum keeps rolling

Executive summary:

The second quarter was a more favourable environment for active managers in Global ex-U.S., U.S. Small Cap, Japan, Australia, and Canada. It was a more challenging quarter for Global, U.S. Large Cap, Emerging Markets, Europe, UK, Listed Infrastructure, and Global Real Estate managers.
The Momentum factor was once again the standout and most relevant positive factor in all regions. Meanwhile, the Quality factor lagged in most markets, with the exception of Emerging Markets, the UK, and Canada.
The information technology sector outperformed in most regions during the second quarter, driven by continued investor enthusiasm over AI.

The Momentum factor picked up where it left off at the end of the first quarter, turning in another standout performance in the April-through-June timeframe and ending the second quarter as the factor most relevant to positive performance. Momentum benefited from continued optimism in markets that inflation is coming under control and that the U.S. economy will be able to achieve a soft landing. While the rate cuts that were predicted at the beginning of the year have yet to materialise in the U.S. and other major markets, investors expect that many central banks will begin easing during the second half of the year.

The performance of other factors was more mixed during the second quarter, with Value outperforming in Japan, Europe, and Emerging Markets (EM) while underperforming in other markets. Notably, the Quality factor underperformed across most markets, except in EM, the UK, and Canada.

Overall, the second quarter was another positive one for most markets in local currencies, but returns were more mixed in U.S. dollars (USD). This was due to a strengthening in the dollar after the timeline for U.S. Federal Reserve (Fed) rate cuts was pushed out and U.S. economic data came in stronger than anticipated. Many markets also continued to experience narrow leadership driven by the information technology sector on the back of the AI (artificial intelligence) theme, which resulted in a challenging environment for active managers.

On balance, the second quarter was a more favourable environment for active managers in Global ex-U.S., U.S. Small Cap, Japan, Australia, and Canada, while being more challenging for Global, U.S. Large Cap, EM, Europe, UK, Listed Infrastructure, and Global Real Estate managers. Sector dispersion remained wide, with narrow and fervent market leadership impeding managers’ relative returns.

The information technology sector was once again the strongest performer across most regions due to investor enthusiasm over the AI theme. Additionally, utilities performed well during the quarter as investors bet on the growing demand for energy driven by increased usage of AI-related hardware. Meanwhile, consumer-related sectors, industrials, and real estate underperformed across most markets, with weakness also seen in the materials sector in the U.S., EM, and Canada.

With inflation on a path to receding and a hard landing appearing increasingly unlikely, investors remain patient for normalisation despite frustrations over the shorter-term in how narrow market returns have been. Many are continuing to question the valuations for some of the tech names that play into the AI theme, including overcapacity and excessive AI capital expenditures.

The main risks in the short-term remain geopolitically driven, including the upcoming U.S. elections in November, which have already contributed to some recent market volatility. The potential for the rate-cutting cycle to be pushed further down the road is also another important watchpoint for investors.

At Russell Investments, our unique relationship with underlying managers affords us special access into the latest active management insights. Here are the key takeaways in second-quarter active management performance from our manager research team.

Global equities

The second quarter was a challenging environment for active Global equity managers while proving favourable for International equity managers, with around 30% and 65% of products outperforming their respective benchmarks.

Growth was the leading factor, while Momentum remained strong due to bullish sentiment amid AI-driven demand.
Information technology (IT) and communication services were key positive contributors. Meanwhile, interest-rate-sensitive cyclicals struggled, including materials, consumer discretionary, and real estate.

China buckled its recent downtrend, rebounding and pulling EM and Asia into positive territory. Conversely, Japan reversed downward following a strong first quarter. The U.S., meanwhile, remained ahead of the broad index, led by the Magnificent Seven group of stocks.

U.S. equities

The second quarter was a challenging environment for active U.S. Large Cap managers while being more favourable for U.S. Small Cap managers, with around 35% and 55% of products outperforming their respective benchmarks.

Momentum and Growth again outperformed in the quarter, though the effect was more evident in Small Cap than Large Cap. Value and Size underperformed on cyclical concerns.
Technology and communication services were the largest outperformers in the quarter, while more cyclical sectors like financials, industrials, materials, and energy trailed the market.
As with the first quarter of 2024 and much of 2023, the largest stocks in the index–especially AI-related names–were the best performing, while smaller-cap, more value-oriented names lagged.

Emerging Markets equities

The second quarter was a challenging environment for active Emerging Markets managers, with around 40% of products outperforming the EM index.

Momentum continued its strong run as the best performing factor. Small Cap also did relatively well, particularly in India, while the Low Volatility and Quality factors struggled.
IT was again the best performing sector, supported by the AI theme, while healthcare and consumer staples lagged.
Latin America underperformed, driven by election-induced volatility in Mexico, while weak commodity prices alongside currency weakness also negatively impacted returns.
China was a tale of two halves, with optimism that sentiment was starting to improve early in the quarter being short-lived.

UK and European equities

The second quarter was a challenging environment for active UK equity and European equity managers, with ~40% and 45% outperforming their respective benchmarks.

Falling interest-rate expectations benefited longer duration stocks in the IT and healthcare sectors.
An economic slowdown in China and declining consumer spending negatively impacted consumer discretionary companies.
The UK outperformed continental Europe. In the UK, mergers and acquisitions (M&A) activity supported asset prices and GDP (gross domestic product) growth rebounded. Political uncertainties, meanwhile, limited optimism on the continent.

Japan equities

The second quarter was a favourable environment for active Japanese equity managers, with around 60% of products outperforming the TOPIX index.

Value and Momentum outperformed strongly while Quality and Small Cap Growth lagged.
The financials and energy sectors delivered strong returns, driven by a rise in 10-year Japanese government bond yields and inflation expectations. Conversely, the real estate and consumer discretionary sectors lagged.
The market's expectation of a soft landing for the U.S. economy led to a risk-on environment, which was supportive for the Momentum factor.

Australian equities

The second quarter was a moderately favourable environment for active Australian equity managers, with around 55% of products outperforming the ASX 300 Index.

The change in expectations that interest rates may increase led financials and defencive sectors such as healthcare and utilities to outperform, while cyclical sectors underperformed.
With many active managers underweight banks, strong performance for the industry was a headwind.
Style was not a driver of active manager returns. Long/short strategies outperformed, while sustainable strategies underperformed due to overweight positions in metal miners.

Canadian equities

The second quarter was a favourable environment for active Canadian Large Cap equity managers, with around 60% of products outperforming the S&P/TSX Index.

Growth strongly outperformed the S&P TSX Index. Quality and Momentum were slightly ahead while Low Volatility and Value lagged.
Materials was the best performing sector, while the consumer staples and energy sectors also outperformed. Healthcare was the worst performing sector in the quarter.

Long/Short equity

The second quarter was a challenging environment for Long/Short strategies, with the HFRI Equity Hedge Index advancing 1.1%. The HFRI Equity Market Neutral Index outperformed the broader HFRI Equity Index, advancing 2.9% as it held up well in April's market decline.

The market environment was tough for alpha generation, as mega-cap growth stocks significantly outperformed the market.
Style was a significant driver of performance, with Growth meaningfully outperforming Value.
U.S. markets once again outperformed, with Latin America and China continuing to underperform.
Some forced selling from a few hedge fund managers during the quarter also impacted volatility and performance.

Real estate and infrastructure

The second quarter was a challenging environment for active Global Listed Real Estate and extremely challenging for Global Infrastructure managers, with around 45% of the former and none of the latter products outperforming their respective benchmarks.

In real estate, exposure to Japan developers was a headwind, while exposure to U.S. healthcare and U.S. technology helped offset losses for the quarter. U.S. industrials held back gains within U.S. real estate.

In infrastructure, exposure to non-benchmark holdings in U.S. rail hurt manager performance on the back of low volumes to end 2023. Meanwhile, underweights to airport services were additive for managers.