Active managers struggled in Q2

The second quarter marked a rough patch for active investment managers, as European sovereign debt woes spawned wide-spread volatility in both the fixed income and equity markets.

Among large cap Canadian equity managers, only 37% beat the S&P/TSX Composite Index, according to the latest Russell Active Manager Report. That’s a precipitous drop from the 75% who beat the index in the first quarter.

Results were not uniform, however. Among dividend-focused managers, 60% beat the benchmark, largely because dividend-paying stocks were seen as a refuge for investors seeking shelter from volatility. Telecom stocks were particularly kind to dividend investors.

“Despite the difficult investing environment for Canadian active managers, those that emphasized dividends or gold in their stock selection process had a better chance of outperforming since risk-averse investors rewarded dividend paying companies and gold stocks,” says Kathleen Wylie, Senior Research Analyst at Russell Investments Canada Limited.

Anyone overweight in gold stocks stood a fair chance of beating the index, as the sector gained 21%, and provided seven of the 10 best performing stocks in the quarter.

“The rise of gold stocks was a significant challenge for Canadian active managers, who tend to be underweight gold. Large cap managers in Canada on average are more than 4% underweight gold stocks,” Wylie says. “Since gold stocks account for roughly 10% of the index weight, that makes it very difficult for active managers to beat the benchmark when those stocks surge.”

She points out that only five of the 101 active managers that Russell tracks were overweight gold stocks at the start of the quarter.

Large cap managers posted average returns of -6.2%, while small cap managers fared even worse, with returns of -6.8%. That broke a five-quarter streak of outperformance by small cap managers, who have outpaced their large cap colleagues by about 115 bps per quarter over the last 10 years.

“There were few places to hide in the small cap space during the quarter, with Health Care being the only sector to post a positive return,” says Wylie. “Small cap managers on average are underweight Health Care, with less than 3% of their portfolios in the sector. As a result, that positioning hurt their performance compared to large cap managers.”

In terms of investment style, 45% of value managers beat the index, while only 24% of growth managers were able to do the same. Value managers still lost money on average, posting a mean return of -6.0%, while the average growth manager posted a -6.9% return.

“Value managers outperformed growth for five consecutive quarters and are on track to outperform again in the third quarter. Their overweights to consumer staples and industrials, as well at their significant underweight to materials, were rewarded in the month of July,” says Wylie. “This is one of those periods when one style is dominating over another. But keep in mind that over the long run, their returns are similar. Styles come in and out of favour and it’s impossible to consistently forecast which will be the most rewarded.”

(08/05/10)