Plunge in Oil Stocks Leads to Widest Range in Manager Returns since 2008: Latest Russell Canada Active Manager Report
- 65% of Canadian large cap managers outperformed their benchmark in the fourth quarter
- 25% difference between the top and bottom manager returns; widest in over six years
- Growth managers led value and dividend managers in 2014 for the first time since 2010
- A challenging start for active managers so far in 2015
TORONTO, February 5, 2015
The active management environment continued to improve throughout 2014, with 65% of Canadian large cap managers beating the S&P/TSX Composite Index in the fourth quarter, completing a straight line progression; 53% the third quarter, 41% in the second and 31% in the first quarter. Using annual returns, 55% of large cap managers beat the benchmark in 2014, down from 94% in 2013, the best year since 2001. The median manager return was 11.3% in 2014, ahead of the S&P/TSX Composite Index return of 10.6%. 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).
Skilled active managers demonstrate value
“It is worth noting that 2014 was the fourth consecutive year that the median large cap manager return exceeded the benchmark. During those four years, 69% of large cap managers outperformed the benchmark on average,” highlights Kathleen Wylie, Head of Canadian Equity Research at Russell Canada. “There are certainly periods that have been more challenging for active managers such as 2009 and 2010,” notes Wylie, “but our data shows that skilled active managers can add value over the long run, contrary to what is often reported in the press.”
Over the last 10 years, 57% of Canadian large cap managers have beaten the benchmark and the median manager return was roughly 80 basis points ahead of the S&P/TSX Composite Index return on average using annual returns. “Keep in mind, our goal is not to invest in the median manager but to find those that can beat the median. The first quartile manager return has averaged roughly 390 basis points in the last 10 years. We believe in active management,” says Wylie.
Sector breadth improved in the fourth quarter
Sector breadth improved in the fourth quarter with eight of 10 sectors beating the benchmark compared to seven of 10 in the third quarter. Large cap managers were favourably positioned in six of 10 sectors, with overweights on average in four of the outperforming sectors and underweights to the underperforming Energy and Materials sectors. However, within Energy, Canadian Natural Resources and Suncor Energy were still widely held by large cap managers at the start of the quarter, hurting those managers’ benchmark-relative performance to some extent. Canadian Natural Resources, held by 79% of large cap managers, fell 16.9% in the quarter and Suncor Energy, held by 70% of managers, fell 8.3%. Gold stocks dropped nearly 14% in the quarter, generally helping managers who were 2.5% underweight on average.
Energy stock performance a key factor impacting the range in manager returns
“The Energy sector accounted for 25% of the Index weight at the start of fourth quarter and had a negative impact on Index performance, as energy stocks fell 16% in the quarter. While investment managers were underweight the Energy sector on average, those that were overweight generally struggled to beat the benchmark in the quarter, in some cases significantly underperforming the benchmark. “Only a handful of stocks in the Energy sector posted positive returns in the quarter, leaving very few places to hide,” says Wylie.
The top large cap manager gained 15.9% in the fourth quarter, while the bottom performer lost 9.3%. This 25% gap between the top- and bottom-performing manager was the largest since the third quarter of 2008 when the financial crisis began and the Energy sector plunged 27%. Prior to 2008, the only other time a range in manager returns this wide occurred was in 2001 when Nortel Networks Corporation was in the midst of its significant decline. “Given the concentrated nature of the Canadian market, we occasionally get these extreme periods where one sector or even one stock can have a significant impact on the active management environment,” says Wylie. “The fourth quarter was one of those periods given the large weight in the Energy sector and the magnitude of the decline.”
Value managers lag other styles for the second consecutive quarter
Although all styles beat the benchmark in the fourth quarter, value managers lagged growth and dividend managers for the second consecutive quarter. The median value manager lost 1.0% compared to a 0.8% loss for dividend-focused managers and a 0.1% gain for growth managers. The S&P/TSX Composite Index lost 1.5% in the fourth quarter, in which 52% of value managers beat the benchmark compared with 57% of dividend-focused and 83% of growth managers.
“It was a stock-specific story again this quarter,” states Wylie. “If you look at sector positioning going in, it appeared as though value managers would have fared the best since they had the largest overweights to Consumer Staples, Information Technology, Consumer Discretionary and Industrials, all outperformers. They also had the largest underweights to Energy so that should have helped.”
For growth managers, it came down to stock selection helped by the top three contributing stocks: Valeant Pharmaceuticals, up 13% and held by 67% of growth managers, Alimentation Couche-Tard, up 36% and held by 91% of growth managers and Enbridge, up 12% and held by 67% of growth managers. None of those stocks were widely held by value or dividend managers.
Growth managers led for 2014 while dividend and value managers lagged
For the year, value and dividend-focused managers struggled relative to the benchmark. The median dividend manager return was 9.1% using annual returns, which lagged the S&P/TSX Composite Index return of 10.6% by roughly 140 basis points. The median value manager return lagged by nearly 60 basis points. Growth managers beat the benchmark by roughly 125 basis points. Again, stock performance drove the differences in style performance for the year more than sector positioning. Of the top 10 contributing stocks for the year, seven were more widely held by growth managers including Canadian National Railway, Valeant Pharmaceuticals and Enbridge. Three of the diversified bank stocks, Royal Bank, Toronto Dominion Bank and Bank of Montreal, were among the top 10 contributors but those stocks tend to be more widely held by dividend managers.
“This is the first year that growth managers have beaten value and dividend since 2010 which highlights that no one style outperforms all the time. Styles come in and out of favour, which is why a multi-style, multi-manager approach will help reduce volatility,” says Wylie.
Active management headwinds so far in 2015
The S&P/TSX Composite was up 0.5% in January but the active management environment looks less favourable so far in 2015 with only six of the 10 sectors ahead of the benchmark (compared to eight of 10 in the fourth quarter). Overall, large cap managers appear to be favourably positioned in only four of 10 sectors. Large cap managers are being helped by their overweights in the Information Technology and Consumer Staples sectors, which are outperforming, and by underweights in the Energy and Financials sectors, which are underperforming. The Health Care and Materials sectors are the top-performers so far this year, which are likely hurting large cap managers who are underweight on average.
“It’s really too early to tell how active managers are performing relative to the benchmark so far in the first month of the year,” highlights Wylie. “Gold stocks were strong in January, up nearly 30%, which would have hurt large cap managers who are underweight on average. Growth managers are likely outperforming value and dividend managers given their smaller underweight to gold stocks. As well, Valeant Pharmaceuticals was again the top contributing stock in January and is widely held by growth managers.”
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