Active investment managers trounced the index in Q3 2015
- 75% of large-cap managers beat the S&P/TSX Composite Index for the period
- All investment styles outperformed the index with dividend-focused managers at the top
- Early look at Q4 2015: October data shows active managers face challenging environment
TORONTO, November 5, 2015
Active management added value in the third quarter of 2015 as 75% of Canadian large-cap investment managers outperformed the S&P/TSX Composite Index, reaching the highest percentage since the fourth quarter of 2013 and increasing from 62% in the second quarter. The median large-cap investment manager return was -6.2% for the third quarter, notably better than the S&P/TSX Composite’s return of -7.9%, which marked its steepest quarterly decline in four years. These and other notable observations are included in the most recent Russell Investments Canada Limited ("Russell Investments Canada") Active Manager Report, which is based on a quarterly survey of 151 Canadian institutional money manager products1.
“No question the third quarter proved difficult for investors and their portfolios given the sell-off in equities both in Canada and globally,” asserted Kathleen Wylie, Head of Canadian Equity Research at Russell Investments Canada, “but amid the negative numbers we saw the value of active managers.”
Russell Investments’ data shows active large-cap managers continue to add value
The third quarter also marked the fifth consecutive quarter that large-cap managers have beaten the benchmark, according to Russell Investments’ report. Further, using one-year returns for the period ending Sept. 30, 2015, 66% of large-cap managers outperformed, exceeding the benchmark by an average of 650 basis points.2
“These relatively high numbers favouring active management may surprise some investors,” says Wylie, “but the objective data speaks for itself. Russell Investments has a robust database with more than 100 Canadian large-cap managers, which is scrutinized every quarter to make sure the data is accurate.”
“We performed additional analysis on the investment returns for this report that reaffirmed active management in Canada added value over the past five years,” Wylie said. This analysis involved looking at 90 large-cap investment managers who reported five-year annualized returns, and correcting for survivorship bias to show that 64% of large-cap managers had indeed outperformed the Index.3 The data also showed that the average excess return of outperforming managers over the five-year period was 330 basis points.
“Our calculations show active large-cap managers outperformed the benchmark whether you slice and dice the data to look at five-year annualized returns or the quarterly average,” Wylie said. “Over the past five years, the median large-cap manager outperformed the benchmark by more than 55 basis points per quarter, while the top quartile manager return was 180 basis points ahead of the benchmark on average per quarter.”
Wylie added there have been periods when active management struggled, and she points to 2009 and 2010 as the most recent examples of challenging years overall. “Investors who wrote off active management in one of those difficult periods likely wish they could revisit that decision given the past five years of outperformance.”
Declines in Valeant, gold stocks and energy stocks help large-cap managers overall
Sector breadth improved in the third quarter of 2015 as seven of 10 sectors beat the benchmark, up from five of 10 in the second quarter. Similarly, active investment managers were favourably positioned in eight of the 10 sectors, although they suffered some pain due to underweights generally to Telecommunication and Financials, which outperformed. In contrast, large-cap managers were helped by the Healthcare, Energy and Materials sectors, which underperformed in the third quarter since they were underweight all three. Within Materials, gold stocks fell by 17%, which helped large-cap managers who were underweight by roughly 2%.
Within Healthcare, large-cap managers benefitted from the 14% decline in Valeant Pharmaceuticals, its first quarterly loss since mid-2014. “Valeant was the top-contributing stock in the Index for the three consecutive previous quarters, which contributed to it becoming a large weight in the benchmark. That made it challenging for large-cap managers to beat the benchmark because it was not widely held,” highlights Wylie. “The stock reversed course during the third quarter when it became the largest negative contributing stock. It was only held by 34% of active large cap managers at the start of third quarter, so the decline helped most managers.”
In assessing large-cap manager performance in the third quarter, Wylie explained that the Energy sector appears to have had the largest impact on investment manager performance. The Energy sector fell 17% in the quarter, representing the largest quarterly decline in four years. Large cap managers on average were roughly 3% underweight the sector so its decline helped most of them. However, Wylie highlighted that those managers who had overweight positions in Energy heading into the quarter were really hurt by the sector’s third-quarter performance.
Wylie stated, “Of the 15 worst-performing managers, 12 had overweight positions in Energy and only two of them held Valeant.”
She added that two Energy stocks—Canadian Natural Resources Limited (CNQ) and Suncor Energy—are still fairly widely held by managers but their performance was mixed. Suncor, held by 67% of large cap managers, was the third top contributing stock, up 4.6%, while CNQ, held by 74% of large-cap managers, was the third bottom-contributing stock, down 23%.
Dividend-focused managers lead as all styles beat the benchmark
Dividend-focused managers fared best relative to other styles in the third quarter as 89% beat the benchmark versus 75% of growth managers and only 57% of value managers. These results showed gains for dividend-focused managers from the second quarter, when 50% beat the benchmark, while 58% of value managers and 75% of growth managers outperformed. The median dividend manager’s return was -5.3% in the third quarter, which favourably compared to -5.5% for growth and -7.1% for value managers. The third quarter marked the sixth consecutive quarter that growth managers outperformed value managers. Wylie says the broad differences in manager style performance for the third quarter are difficult to explain. “Looking strictly at overall sector positioning, it appears on the surface that value managers should have come out ahead of their growth and dividend-focused counterparts, so it came down to stock specifics and the individual holdings of each manager.”
She added that dividend managers would have been most helped by the decline in Valeant since only one dividend manager (representing less than 4% of the dividend managers in the survey) held it at the start of the quarter compared to 75% of growth and 12% of value managers. They also benefited relatively more from the underperformance of gold stocks since they are underweight by 3.3% on average compared to 1.6% underweight for growth managers and 2.7% for value managers.
To further explain why growth managers fared better than their value counterparts for the quarter, Wylie said of the top five contributing stocks to the Index in the third quarter, the top three, Alimentation Couche-Tard, Canadian National Railway and Suncor, were more widely held by growth managers. The other two top contributing stocks, Canadian Imperial Bank of Commerce and Thomson Reuters, were more widely held by dividend managers.
Wylie clarified that while value managers on average were more underweight Energy than growth or dividend managers, 30% of them were overweight Energy. Eight of the 12 bottom-performing managers with overweights to Energy were value managers, which she added helps to explain why they lagged the other styles.
Although growth managers have outperformed value managers in recent quarters, Russell Investments’ data shows that over longer periods the two tend to perform similarly. In the past five years, value managers have outperformed growth by only one basis point on average, and over 10 years growth is ahead by just four basis points. “Styles come in and out of favour,” highlights Wylie, “but it’s impossible to time the change, so that’s why we recommend a multi-manager, multi-style and multi-asset approach at Russell Investments.”
Looking at October returns: Active management may be challenged so far in the 4Q
Although the S&P/TSX Composite Index has moved into positive territory with a return of 2% during the month of October, the final quarter of the year appears challenging so far for large-cap managers to beat the benchmark. Sector breadth was slightly narrower as of the end of October with six of the 10 sectors ahead, while managers were only favourably positioned in three sectors. Energy and Materials were the top performing sectors for October, which could hurt large-cap managers who were underweight both sectors on average at the end of the third quarter. Gold stocks were stronger in October, up 8%, which would also hurt benchmark-relative performance to a certain extent since managers were underweight on average at the end of the third quarter. On a positive note for investment managers not holding Valeant Pharmaceuticals in October, the stock’s decline accelerated in October, down nearly 50%. In addition, bank stocks outperformed in October with the most widely held at the end of the third quarter – Bank of Nova Scotia, Toronto Dominion Bank and Royal Bank – all stronger than the Index for the month of October.
“It’s too early to tell but it’s not looking like a favourable environment for large-cap managers in terms of beating the benchmark,” said Wylie. “Valeant’s plunge will help most managers, but its weighting has been cut in half so it won’t have as much of an impact on benchmark-relative manager performance now as it did earlier this year when it briefly became the largest stock in the Index.”
In terms of style, Wylie said it’s not clear so far this quarter how the different investment styles are performing. Growth managers would benefit most from the strength in Energy and Materials, including golds, since they have smaller underweights than value and dividend managers, but the plunge in Valeant would hurt their benchmark-relative performance more. The strength in Telecommunication and Financials in October would benefit dividend managers most while value managers would benefit from having a larger overweight to Industrials, which are outperforming and a smaller overweight to Consumer Staples, which are lagging.
“Even if the year ends on a negative note and the majority of large-cap managers lag the benchmark, it is important to understand that active managers are not expected to beat the benchmark every quarter or even every year,” Wylie stressed. “A key benefit of active managers is that they make educated and decisive decisions on which stocks to hold rather than having to hold every stock in the Index, and that can certainly help their benchmark-relative performance in certain environments.”
For more information on this report and findings from previous quarters, please visit: https://russellinvestments.com/ca/insights/active-manager-report
1 All data cited in the quarterly Russell Canada Active Manager Report is gross of fees as of Sept. 30, 2015
2 Russell Investments currently has one-year performance for 111 large-cap managers and 79 of those outperformed the S&P/TSX Composite Index. To adjust for survivorship bias and take a conservative approach, the firm assumed the nine managers who no longer provide data were underperformers even though some might still exist and may have outperformed so the calculation is actually 79/(111+9)=66%. Alternately, the firm also highlights that an average of the quarterly % of managers that beat the benchmark over the one-year period equals 64%.
3 Russell Investments currently has five-year performance for 90 large-cap managers and 81 of those outperformed the S&P/TSX Composite Index. To adjust for survivorship bias and take a conservative approach, the firm assumed the 36 managers who no longer provide data were underperformers even though some might still exist and may have outperformed so the calculation is actually 81/(90+36)=64%.)
4 The quarterly average shows 61% beat the benchmark over the last five years.
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