Surge in Valeant Pharmaceuticals increases pain for Value and Dividend investment managers: Latest Russell Canada Active Manager Report

  • Only 39% of value and 34% of dividend managers beat the benchmark in 1Q 2015; versus 75% of growth managers
  • Growth managers outperformed their value counterparts for the fourth consecutive quarter
  • Early look at 2Q 2015 shows mixed results for active managers, hinging on stock selection

TORONTO, May 7, 2015

While 2015 started on a healthy note for the S&P/TSX Composite Index, which gained 2.6% for the first quarter after two negative quarters, a majority of large cap investment managers in Canada faced an extra valiant challenge. Valeant Pharmaceuticals International’s stock price surged 50% in the quarter and accounted for more than half the benchmark index’s gain, but only 35% of large cap managers in Canada held Valeant Pharmaceuticals at the start of 2015. Despite this predicament, 53% of Canadian large cap managers beat the benchmark for the first quarter, albeit down from 65% in the fourth quarter of 2014. In addition, the median large cap manager returned 2.9%, slightly outperforming the benchmark. These and other notable observations are included in the most recent Russell Investments Canada Limited (“Russell Canada”) Active Manager Report, which is based on a quarterly survey of roughly 150 institutional money manager products (all data cited is gross of fees).

“We know that the Canadian market is prone to concentration issues,” explains Kathleen Wylie, Head of Canadian Equity Research at Russell Canada. “We had Nortel back in 1998/1999, and in recent years the large weight of resources, financials and gold stocks in the index has presented challenges for managers at different times. Valeant Pharmaceuticals is now the latest concentration issue given it is the third-largest stock in the index with a weight of more than 4%. Concentration can make it problematic for active managers to beat the benchmark in certain quarters, especially when one of the largest stocks or sectors in the index surge.”

Wylie added that despite those challenges, an average of 58% of large cap managers have beaten the benchmark over the last five years, according to the Russell Canada report, with the median manager ahead of the benchmark by more than 40 basis points on average per quarter. Over 10 years on average per quarter, her findings show that 54% of large cap managers have beaten the benchmark, with the median return nearly 20 basis points ahead of the benchmark and the first quartile manager roughly 150 basis points ahead.

“Skilled active managers can add value over the long run,” Wylie summarized.

Report reveals less sector breadth in the first quarter

Russell Canada’s report also found that sector breadth was slightly less favourable in the first quarter of 2015, with six out of 10 sectors beating the benchmark, down from eight out of 10 in the fourth quarter of 2014. In addition, large cap managers were favourably positioned in six of the sectors, primarily helped by their average overweights to the outperforming sectors— including Information Technology, Consumer Discretionary and Consumer Staples—and underweights to the three most underperforming sectors: Telecommunications, Financials and Energy. As for precious metals, gold stocks rose 3.9% in the first quarter after falling nearly 14% in the fourth.

“Large cap managers on average started the quarter 2.2% underweight gold stocks so the strength hurt their benchmark-relative performance to some extent,” said Wylie, who also noted that this underweight by managers is the smallest since Russell has been closely tracking the data. The weight of gold stocks in the Index started the quarter at 4.2%, down significantly from a peak of 14% in 2011 when large cap managers were nearly 6% underweight on average.

Value and Dividend Managers Struggle Most in the Quarter

The surge for Valeant Pharmaceutical’s stock price in the quarter had the biggest negative impact on value and dividend managers, many of whom were not holding the stock. Only 13% of value managers and 11% of dividend managers owned Valeant Pharmaceuticals at the start of the quarter, which made it challenging for them to beat the benchmark. Only 39% of value and 34% of dividend managers were able the beat the benchmark in the first quarter, down from 52% and 57%, respectively, from the fourth quarter of 2014. Value and Dividend managers would also have been hurt by the rise in gold stocks. On average, value managers were 2.8% underweight gold stocks at the start of the quarter and dividend managers were 3.1% underweight. On the other hand, 75% of growth managers beat the benchmark in the first quarter. Growth managers were less underweight gold stocks, only 1.4% on average, and the majority of them (67%) held Valeant Pharmaceuticals, which also helped their benchmark-relative performance. The median growth manager’s return was 4.3%, compared to only 1.5% for value and 1.6% for dividend managers in the first quarter.

“This was the fourth consecutive quarter that growth managers have outperformed value managers,” highlights Wylie. “Growth managers struggled during the financial crisis, particularly in 2011 and 2012 when the market was rewarding value and dividend managers the most, but the tide seems to have shifted in the last year,” says Wylie. “We have observed that investment styles come in and out of favour, which is why a multi-style, multi-manager approach is essential to helping reduce volatility.”

Diversified Bank Performance Negative in the Quarter

The performance of diversified banks also had an impact on large cap manager performance in the quarter. As a group, they fell 3.9%, with five of the six biggest banks ranking among the top 10 largest negative contributing stocks. Although large cap managers overall were underweight the group by 4.2% at the start of the quarter, three of those banks—Royal Bank, Bank of Nova Scotia and Toronto Dominion Bank—were held by at least 80% of large cap managers, and so their performance negatively impacted benchmark-relative performance. Those three stocks were also more widely held by dividend mangers, which helped to explain why dividend managers lagged.

Active management mixed so far in in the second quarter

The market is off to a solid start in the second quarter with the S&P/TSX Composite Index up 2.4% for the month of April. Still, the active management environment looks less favourable, with only four of the 10 sectors ahead of the benchmark (compared to six of 10 in the first quarter) and Energy and Materials the top-performing sectors. Overall, large cap managers appear to be favourably positioned in only two of 10 sectors but stock selection is also having a significant impact in the second quarter. Energy is the top-performing sector and although large cap managers are underweight the sector on average, Canadian Natural Resources and Suncor are still widely held and outperforming so far in the quarter. Offsetting that to some extent, however, is Encana— the top-contributing stock in the Energy sector in April—, which is held by less than 40% of large cap managers.

Managers also continue to be challenged by strength in Valeant Pharmaceuticals and gold stocks, which outperformed in April. On a positive note, diversified bank stocks are rebounding in the quarter, led by Royal Bank, Bank of Nova Scotia and Toronto Dominion.

“It’s always challenging to figure out which style will outperform when it’s so early in the quarter,” says Wylie. “Based on overall sector positioning, and the strength in gold stocks and Valeant Pharmaceuticals, growth managers are likely outperforming again. However, the top-performing bank stocks are more widely held by dividend managers so that may help their performance. It’s just too early to make a call on style since it changes day-to-day. It will come down to stock selection.”

Growth mangers currently have their largest overweights to the Information Technology and Consumer Discretionary sector and their largest underweights to Financials and Telecommunications. Value managers also have their largest overweights to Information Technology and Consumer Discretionary but their largest underweights to Financials and Energy. Dividend managers have their largest overweights to Utilities and Consumer Discretionary and their largest underweights to Energy and Materials.

For more information on this report and findings from previous quarters, please go to: Active Manager Report

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