Growth tops value in tough quarter

The third quarter of the year proved to be a tough one for active investment managers, according to the Russell Active Manager Report, as fewer than half outperformed their benchmarks.

According to the survey, only 45% of large cap Canadian equity investment managers beat the S&P/TSX Composite this quarter. That’s down from 53% in Q2 and 65% in Q1.

Kathleen Wylie, a senior research analyst at Russell Investments Canada, says the decline is due to less breadth in the market. She points to the fact that only three out of 10 sectors beat the benchmark, compared to six out of 10 the quarter before.

One reason for the underperformance of the majority of sectors could be the market turmoil the industry has faced over the past few months. Philip Lee, a fund analyst at Morningstar Canada, says the recent volatility has affected the financial sector — one of the more important sectors for active managers. “Banks took it pretty hard, so it’s not surprising at all that the numbers are down,” he says.

Wylie isn’t so sure that market troubles affected the percentages. She says people need to look at the entire quarter, not just a month here and there. “Some managers struggled in August; they came back in September,” she explains. “To really understand it, you have to look at the style issue.”

When it comes to style — value versus growth — the numbers are really surprising, says Wylie. Only 9% of value managers beat the benchmark, while 75% of growth managers outperformed the S&P/TSX Composite. “That’s the lowest I’ve seen value at since I’ve been tracking this,” she says.

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The disparity can be attributed to the 1% underweight that the average value manager has in information technology, which was the top-performing sector in the third quarter. Growth managers, on the other hand, were 3% overweight in IT.

As well, value managers were underweight in the materials sector, which also performed well. “Most value managers were underweight in gold stocks at a time when the S&P/TSX Gold Index was up 14% in the quarter,” says the report.

“Value funds have had it good for several years now,” adds Lee. “It’s been a tough battle for growth managers, so perhaps the table’s turning for them.”

Lee points out that a possible explanation for the shift to growth from value is that “value names have really run up in valuations, so it makes sense that investors are taking some money off the table. Traditional growth areas have been neglected and are now getting more attention.”

Another major difference between Q3 and quarters past is that for the first time in 2007, large-cap managers outperformed small-cap managers. The median small-cap fund return was -1.3%, compared to the median large-cap fund return of +1.7%.

“Eight out of 10 sectors posted negative returns in the quarter,” says Wylie. “That really hurt small-cap managers and also any large-cap managers who dipped down into the small-cap space.”

The report says that small-cap managers usually have about 5% more of their portfolio in industrial and consumer discretionary stocks than large-cap. These sectors underperformed and, therefore, hurt the small-cap space.

So what do these negative numbers mean? Wylie says this just proves that investors can’t pick one style of manager. “It’s the perfect case for the multi-style, multi-manager approach.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(10/25/07)

Bryan Borzykowski