After a strong year for active managers in 2013, less than a third (31%) of large-cap managers were able to beat the S&P/TSX Composite Index in the first quarter of 2014, down from 86% in the previous quarter. The median manager return in the quarter was 5.5%, behind the S&P/TSX Composite Index return of 6.1%.
During the first quarter, five of 10 sectors beat the benchmark, but investment managers were only favourably positioned in four. The top-three performing sectors in Canada were Healthcare, Materials and Energy and Canadian large-cap managers were underweight all three at the start of the quarter.
The strength in Healthcare was driven by Valeant Pharmaceuticals, up nearly 17% but only held by 37% of large cap managers. The largest negative contributing stock in the quarter was Teck Resources, down nearly 14% and held by 58% of large cap managers. Large cap managers had their largest overweight to Consumer Discretionary, Information Technology, and Industrials, three underperforming sectors.
Within Materials, gold stocks rose 12% in the quarter. “The weight of gold stocks in the Index was only 5% at the start of the first quarter, but active managers were still 2% underweight so that hurt their benchmark relative performance to some extent,” explains Kathleen Wylie, head of Canadian Equity Research at Russell Investments.
“The good news is that gold stock performance is having less of an impact on benchmark relative performance now than in the past when gold peaked at 14% of the Index and large cap managers were 6% underweight on average.”
All Styles Lagged
Value managers fared slightly better than growth and dividend managers in the first quarter, with 33% beating the benchmark. That compares to only 25% of growth and 15% of dividend managers beating the benchmark.
The median value manager return was 5.5%, just slightly ahead of the median growth manager return of 5.4%.
The median dividend manager return was 4.3%. Dividend managers struggled the most due in part to their overweight to Telecom stocks, which underperformed. They also have the biggest underweight to gold stocks at nearly 4% compared to 1.5% for growth and 2% for value managers. And they have a larger weight in Financials compared to the other styles.
Small-Cap Managers Ahead of Large-Cap
For the fifth consecutive quarter, small-cap managers in Canada have beaten their large-cap counterparts. In the first quarter, the median small-cap return was 7.9% compared to the median large-cap return of 5.5%. Small cap manager performance matched the S&P/TSX Small Cap Index return of 7.9%, ahead of the S&P/TSX Composite return of 6.1%. In the first quarter, 46% of small-cap managers beat their benchmark, down from 92% in the fourth quarter.
Sector breadth in the small-cap space was narrower, with only four sectors beating the benchmark and small-cap managers on average underweight the outperforming sectors, which were Energy, Materials, Healthcare and Utilities. “Small-cap managers who were overweight Energy and underweight Financials did best in the quarter but it looks like stock selection rather than sector positioning was key for most managers that outperformed,” states Wylie.
Although small-cap manager returns can be volatile, they have added significant value against the benchmark and relative to large-cap managers. Over the last 10 years, the median small-cap manager was ahead of the benchmark by roughly 160 basis points on average per quarter and beat the median large-cap manager by nearly 65 basis points on average per quarter.
Second Quarter looks better
Although it’s still early, the environment for active managers appears to be more favourable so far in the second quarter. Sector breadth is worse, with only three of 10 sectors ahead of the benchmark, but large-cap managers are favourably positioned in six of them.
Although Energy is the top-performing sector and large-cap managers on average are underweight, they are benefitting from their overweight to Information Technology and Industrials which are both outperforming. Large-cap managers have their largest underweights to the Materials and Financials sectors, which is helping their benchmark relative performance since both sectors are underperforming.
“It’s not clear which style is ahead so far this quarter,” says Wylie. Growth managers are likely benefiting from their larger overweight to Information Technology and their underweight to Telecom, while value managers are likely being helped by a larger overweight on average to Industrials and a large underweight to Financials. Dividend managers would benefit most from the decline in gold stocks so far this quarter since they have the largest underweight.