New data from the Russell Active Manager Report shows Canadian large cap growth managers in Canada gained 11.1% in the final quarter of 2010, their highest return since the first quarter of 2009. This also beats the S&P/TSX Composite Index’s return of 9.4% and the median value manager’s return of 9.1% during the same period.
“The difference in performance between growth and value managers last quarter was also the largest since the second quarter of 2008,” notes Kathleen Wylie, senior research analyst with Russell Investments Canada.
“Growth managers were more favourably positioned in 9 out of 10 S&P/TSX sectors. Energy and materials were the top-contributing sectors. Growth managers are slightly overweight Energy and have less of an underweight in materials compared to value managers,” she adds.
Compared to value managers, growth managers held Canadian Natural Resources and Teck stocks more widely and at larger weights. Canadian Natural Resources was up 25% and Teck Resources 47% in the fourth quarter of 2010. Owning less Encana and Bank of Montreal also helped growth managers, as these stocks—more widely held by value managers—were among the largest negative contributors to the index return.
More large cap managers beat benchmark
Overall, 52% of large cap managers in Canada exceeded the benchmark in the fourth quarter of 2010, up from only 34% in the third quarter and 37% in the second quarter.
“The 52% is in line with the 10-year average. However, it’s worth noting that without the underperformance of the dividend managers who struggled significantly in the quarter, the number would have jumped to 62% so we can conclude that it was generally a good quarter for active managers,” says Wylie.
“I’m surprised that large cap managers did as well as they did given the strength in the materials and energy sectors and narrow sector breadth overall. Large cap managers are roughly 6% underweight materials and 2% underweight energy on average and typically when those two sectors are the top-performing sectors, managers find it a challenge to beat the benchmark, particularly when there is narrow sector breadth. Clearly, even though their sector bets were not rewarded, stock-picking was a driver of individual investment manager returns in the fourth quarter, which is what we expect in the long run.”
The median return for large cap managers was 9.6%, just ahead of the benchmark return of 9.4%. The difference between the top-performing and the bottom-performing manager return was over 13%, the largest since the second quarter of 2009 but still notably below the historical average of 17%.
“The investment managers I met with recently indicated it was a more of a stock-pickers market for active managers last quarter. They expect the stock-pickers market to extend into 2011,” Wylie says.
“If correlations of stocks remain low and company fundamentals continue to be rewarded as we expect, investment managers with skill in stock-picking and portfolio construction should be able to add more value so we expect the difference between the top- and bottom-performing managers to continue to widen.”
Starting strong in 2011
The S&P/TSX Composite Index appears to be starting the year on a positive note, with strong sector breadth and the materials sector lagging the benchmark.
“Since large cap managers in Canada have their largest underweight to materials, any underperformance of those stocks will help them beat the benchmark,” says Wylie.
Underperforming gold stocks is also positive for large cap managers in terms of benchmark relative performance. The 13% drop in gold stocks in early January helps active managers because on average they are about 5% underweight on these stocks.
Wylie explains, “Large cap managers have their largest overweights in consumer discretionary, industrials and information technology stocks, so if the strength in those sectors continues, that should help large cap managers’ benchmark relative performance.”
“Early indications are that the value style of investing might be more rewarded in the first quarter of 2011 with value managers more favourably positioned in 8 out of 10 sectors compared to growth managers, based on sector performance so far in January,” she adds.
Wylie suggests the performance of the top three most heavily weighted S&P/TSX Composite sectors—energy, materials and financials—will determine which approach will be favoured, since the positioning of those sectors is markedly different for value and growth managers.
“Value managers are underweight energy while growth managers have a slight overweight and growth managers are underweight Financials while value managers are overweight. Value managers have a larger underweight to materials, particularly gold, compared to growth managers,” says Wylie. “There’s a perception that there’s no style in Canada because most managers hold the big banks. However, that’s clearly not the case when you dig down into the positioning of value and growth managers’ portfolios and compare their quarterly performance. If you look back over the last 20 years, there is no significant difference in performance between the two styles but over shorter time periods, there have some extreme differences in performance and extended periods where one style will dominate.”
“That’s why it’s important,” Wylie concludes, “to have a multi-style approach to investing so that you can diversify your portfolio, reduce risk, and weather the swings in the markets.”