Active managers miss out on materials rally

“Small cap managers have outperformed large cap managers in six out of the last seven quarters after lagging large cap managers for most of the previous four years,” says Kathleen Wylie, senior research analyst at Russell Investments Canada Limited.

She points out that over the last 10 years, the median small cap manager has topped the median large-cap manager by an average of 115 basis points.

In the most recent quarter, Wylie attributes much of the outperformance to the strong commodities rally—the materials sector makes up 21% of the average small-cap portfolio, compared to 15% of the average large-cap portfolio.

The S&P/TSX SmallCap Index, however, has an even greater exposure to materials (32%) than the average actively managed portfolio, and the index saw a gain of 14.2%. Only 29% of active small-cap managers could beat that.

Large-cap active managers were also caught offside on the materials rally, with an average underweighting of six percentage points, compared to the S&P/TSX Composite Index. Only 34% of active managers were able to beat the benchmark’s 18.2% return for the quarter.

Wylie explains that the majority of managers were able to beat the index in July and September (with 63% and 56% topping it, respectively), but that concerns about the U.S. economy in August slashed the number of outperformers to just 19%, as the price of gold skyrocketed.

“Large cap managers on average are almost 5% underweight the gold stocks in Canada so when gold outperforms, it’s difficult for active managers to beat the benchmark since gold stocks now account for roughly 13% of the S&P/TSX’s weight,” she says.

Still, she points out that the median large cap manager has been able to beat benchmark by 40 basis points on average per quarter over the last 10 years.

“Keep in mind that’s a median return. Therefore half the universe of large cap managers beat the benchmark by more than 40 basis points per quarter,” she says. “Historically, managers with skill in stock research and portfolio construction have been proven to add significant value above the benchmark over long periods of time.”

Growth tops value
Within the active management sphere, 47% of growth managers beat the benchmark, compared to 31% of value managers. This is contrary to the trend since 2008, when value managers started to outperform growth in most quarters.

“The major difference in returns was stock specific. If you look at the top five contributing stocks, Potash, Bank of Nova Scotia, Toronto Dominion Bank, Teck Resources and Royal Bank, a smaller percentage of value managers owned these stocks and they tended to own them at lower weights compared to growth managers,” Wylie explains.

(11/03/10)