Russell Investments Canada Active Manager Report: Bank and gold stocks help large cap managers overcome the pain of not holding Valeant

  • Active management environment proved favourable in Q2 2015 as 62% beat the benchmark
  • Growth managers have outperformed their value counterparts for five consecutive quarters
  • Early look at Q3 2015: Data shows active managers continued to outperform in July, August 6, 2015

The median large cap investment manager in Canada returned -1.4% for the second quarter of 2015, outperforming the S&P/TSX Composite which fell 1.6% for the period. In addition, nearly two-thirds (62%) beat the index for the second quarter, increasing from 53% in the first quarter. These and other notable observations are included in the most recent Russell Investments Canada Active Manager Report, which is based on a quarterly survey of roughly 155 institutional money manager products1.

“No one likes to lose money,” highlighted Kathleen Wylie, Head of Canadian Equity Research at RussellInvestments Canada, “Despite a negative return for the quarter, not losing as much as the index does help a manager’s long-term performance relative to the benchmark.”

Wylie added that over the past five years, the median manager outperformed the benchmark by more than 45 basis points on average per quarter, while managers in the top quartile averaged roughly 165 basis points ahead of the benchmark. Among the full universe of money managers surveyed, an average of 59% beat the benchmark for the five-year period.

Gold and diversified bank stocks helped large cap managers

Sector breadth narrowed in the second quarter of 2015 with only five of 10 sectors beating the benchmark, down from six of 10 in the first quarter. In addition, large cap managers were favourably positioned in only five of the sectors, primarily helped by their average overweight positions to the outperforming sectors—Consumer Discretionary and Consumer Staples—and underweight positions to the underperforming Energy, Materials and Utilities sectors. Within Materials, gold stocks reversed course in the second quarter, declining by almost 4%. Wylie pointed out that declines in gold stocks tend to benefit benchmark-relative performance for large cap managers as, on average, they are underweight by roughly 2%.

Large cap managers also benefited from relative strength in select bank stocks. Although large cap managers are underweight the diversified bank group overall, the Bank of Nova Scotia, Toronto-Dominion Bank (TD) and Royal Bank are all widely held by large cap managers.

Toronto-Dominion Bank, for example, fell 1.2% in the second quarter but still outperformed the Index. “This helped large cap managers because at the start of the quarter, 87% of them held TD, which ranked as the most widely held stock in Canada,” explained Wylie. “Similarly, Bank of Nova Scotia and Royal Bank posted positive returns and were held by 86% and 82% of large cap managers, respectively.”

Continuing to confound large cap managers, though, Valeant Pharmaceuticals rose 11% in the second quarter and again ranked as the top contributing stock to the Index. The stock was only held by 35% of large cap managers in Canada so the strength continued to hurt benchmark-relative performance overall given its large weight in the Index. (Russell Investments’ latest data shows that 13% of value managers, 7% of dividend managers and 75% of growth managers held Valeant at the start of the second quarter.)

“We’re watching investment managers’ portfolios closely to see if anyone capitulates and adds Valeant to their portfolio given the strong price momentum in the last year,” said Wylie. She added that Valeant has increased 155% in the past year and recently moved above a 6% weight in the Index, ranking above Royal Bank as the largest stock in the Index in July. By comparison, the S&P/TSX Composite Index fell by 4.6% over the same one-year period.

“Earlier this year, we noticed that one dividend-focused manager sold Valeant, and a growth manager added it,” highlighted Wylie. “If instead we begin to see value or dividend managers adding it too, we’d likely view that move as a deviation from their style objectives.”

Value and dividend managers continue to lag growth

In the second quarter, 58% of value managers and 50% of dividend managers were able to beat the benchmark, which was an improvement from 39% and 34%, respectively, in the first quarter. Growth managers fared better with 75% beating the benchmark in the second quarter, similar to the first quarter. The median growth manager return was -0.9%, comparing favorably to -1.4% for value and -1.7% for dividend managers in the second quarter. Growth managers would have been helped by the strength in Valeant, but that was offset by a decline in gold stocks since they tend to be less underweight gold stocks compared to value and dividend managers. On average, growth managers were 1.4% underweight gold stocks at the start of the second quarter, compared to 2.9% underweight for value managers and 3.3% underweight for dividend managers.

“The second quarter proved tough trying to determine why any style fared better than others,” explained Wylie. “If you compare the overall sector positioning of each of the styles, dividend managers should have come out ahead. They were more favourably positioned in the outperforming Telecommunication Services, Financials and Consumer Staples sectors as well as the underperforming Materials, Information Technology and Industrials sectors. Their larger underweight to gold stocks should have helped them as well, which indicates that it must have come down to individual stock selection, mainly Valeant, in each manager’s portfolio that drove the differences in performance.”

Active management looks favourable so far in the 3Q

The third quarter of 2015 started on a better note with the S&P/TSX Composite down 0.3% in the the month of July. For active managers, the environment appeared favourable based on sector performance. Sector breadth quarter-to-date looked positive with eight of 10 sectors ahead, but a good sign for large cap managers is that the Energy and Materials sectors underperformed for the period. Large cap managers appeared to be favourably positioned in six of the 10 sectors. Also helping benchmark-relative performance was a significant decline in gold stocks, though some of that appears likely to be offset by the continued strength of Valeant, which was the top contributing stock in the index in July.

“Early signs indicate an even better environment for active managers in the third quarter given sector performance, but it’s too early to tell,” said Wylie. “If Valeant continues its relatively strong run, growth managers may do well again, particularly given how large the weight is in the index.”

She added that the decline of gold stocks helps large cap managers overall but benefits dividend managers more since they have the largest underweight positions. In addition, the performance of bank stocks in her view appears likely to continue playing a major role in shaping the active management environment and is likely positive since the most widely held bank stocks, Toronto Dominion Bank, Bank of Nova Scotia and Royal Bank, outperformed in July.

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

1All data cited in the quarterly Active Manager Report is gross of fees.

About Russell Investments

Russell Investments is a global asset manager and one of only a few firms that offers actively managed multi-asset portfolios and services that include advice, investments and implementation. Russell Investments stands with institutional investors, financial advisors and individuals working with their advisors—using the firm’s core capabilities that extend across capital market insights, manager research, asset allocation, portfolio implementation and factor exposures to help each achieve their desired investment outcomes.

Russell Investments has more than CAD$315 billion in assets under management (as of 3/31/2015) and works with over 2,500 institutional clients, independent distribution partners and individual investors globally. As a consultant to some of the largest pools of capital in the world, the firm has US$2.4 trillion in assets under advisement (as of 12/31/2014). It has four decades of experience researching and selecting investment managers and meets annually with more than 2,200 managers around the world. Russell Investments traded more than US$1.7 trillion in 2014 through its implementation services business. The firm also calculates approximately 700,000 benchmarks daily covering 98% of the investable market globally, including more than 80 countries and more than 10,000 securities.

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