Active managers do well, but lag index

Asset managers focused on the large cap space posted their best returns in 22 years in the second quarter as Canadian equity markets roared back to life. But the return of the bull made it difficult to beat the overall benchmark, according to the latest Russell Active Manager Report.

The median large cap manager earned a return of 19.1% over the quarter, falling just short of the S&P/TSX Composite Index’s return of 20%. Only 38% of large cap managers beat the benchmark.

“Considering the fact that sector performance was narrow with only three out of 10 sectors beating the benchmark during the second quarter, active managers did very well in that environment,” says Kathleen Wylie, senior research analyst with Russell Investments Canada Ltd.

The financial services sector provided most of the lift for the TSX, gaining 35%. Despite being outperformed by the tech sector, which gained 43%, the sheer size of the financial sector contributed more to the overall gain.

Financials were at the centre of the storm as the global credit crisis hit, with Canadian institutions tarred with the same brush as their struggling American cousins. That sell-off opened the door to buying banks and insurers at near fire-sale valuations.

Many active managers shifted assets back into financials in the second quarter, shifting to a modest overweight position on average, according to Wylie. At the same time, they were largely selling off their holdings in the materials sector, which proved to be another good move, as materials lagged the composite index.

But many managers were caught wrong-footed by rising share values in the energy sector, in which the average portfolio was underweighted.

“[Large cap managers] were able to mitigate some of the unfavourable positioning with stock selection—particularly by investing in Canadian banks, which are very popular with Canadian large cap investment managers and were strong performers in the quarter,” says Wylie.

The financials-led charge did help one subset of managers—57% of value-oriented managers beat the benchmark. Growth managers lagged with 40% beating the index, marking a reversal from the first quarter when 47% of growth managers beat the index compared to 37% of value managers.

For the second quarter, the median return for value managers was 20.7%, beating out growth managers by one percentage point.

“Stock selection was key in the quarter and it appears that what value managers did not hold was as important as what they held,” says Wylie. “For example, six out of 10 of the bottom-contributing stocks were gold companies, and with the exception of Barrick Gold, those stocks tend to be more widely held by growth managers than value managers and at larger weights.”

One month into the third quarter, the financial sector is the only one to outpace the overall index, making July a tricky month for active managers. But Wylie points out that the first two weeks of August saw a broadening of the market, with more sectors joining the rally.

“It’s encouraging that the environment looks more promising for active managers in the third quarter after two quarters of lagging the benchmark,” she says. “In the short term, the market is not always driven by fundamentals but they do matter. Investment managers that have skill in finding quality companies trading at reasonable prices and actively repositioning their portfolios will be rewarded in the long run.”

The Russell Active Manager Report is a quarterly analysis of institutional investment managers.

(08/12/09)