Russell report: Fund managers challenged by rally

(July 21, 2003) Mutual fund managers may have been too cautious in the second quarter, shying away from debt-ridden companies that have powered the recent rally of the S&P/TSX Composite Index, according to the Russell Canadian Active Manager report.

“The average share price appreciation of the 20 companies within the index having the greatest debt-to-equity ratios was a spectacular 19.1% this quarter,” noted Paul Carter, senior research analyst at Frank Russell Canada.

Canadian mutual funds generally lagged behind the S&P/TSX Composite index by a full percentage point in the second quarter. The index was up 10.6% in the second quarter of 2003, while the median return for equity managers was an estimated 9.5%.

Also skewing the results in favour of the index, though, were individual companies that might not have matched a given manager’s investment style. For example, if Fairfax Financial didn’t seem to match an aggressive growth strategy, such a manager would have missed out on the 173% rise in the stock. Similarly, value fund managers might have missed out on the 86% gains posted by Angiotech.

But the report says that the traditional distinction between growth and value might not be so distinct in the current market conditions. Celestica is given as an example of a company that might fit both strategies.

“For many years Celestica has been attractive to growth investors as it grew its revenues by 200% from 1998 to 2001,” said Carter. “But it has recently found some fans among the universe of value managers since losses have mounted, revenue growth stalled, and the stock got hammered.”

While the equity managers posted respectable return, fixed income managers were thrown a curve by the changing policy at the Bank of Canada. There was the expectation of a tightening money supply originally, but managers had to rethink their strategies when it became clear that the bank was shifting its bias toward easing rates.

In mid-April, the bank was predicting strong growth for the Canadian economy and was warning that inflation could creep above the 2% target. But as the toll taken by severe acute respiratory syndrome (SARS) and mad cow disease became clear, the bank changed course, eventually surprising the markets with a rate cut earlier this week.

“Those active managers with an overweight to non-Government of Canada bonds and a longer-than-index duration benefited the most from the market moves during the quarter, since long bonds outperformed both mid- and short-term bonds, while the performance of provincial and corporate bonds outpaced that of Government of Canada securities,” said Greg Nott, Russell’s senior fixed income research analyst.

Filed by Steven Lamb, Advisor.ca slamb@rmpublishing.com