Canadian active managers continue to benefit from a stock picker’s market in 2010, although the Greece-debt situation and looming interest rate hikes are weighing in on the markets in the second quarter.

According to the latest results of the Russell Active Manager Report, 75% of Canadian large cap active managers beat the S&P/TSX Composite Index in the first quarter of 2010, the highest level since the second quarter of 2004.

The outperformance was up from the 57% of active managers that beat the S&P/TSX benchmark in the fourth quarter of 2009. The Russell report is based on 135 actively managed institutional products in Canada.

“The last two quarters have really highlighted the benefits of active management. Large cap managers in Canada have outperformed the S&P/TSX benchmark by 53 basis points on average per quarter over the last 10 years,” says Kathleen Wylie, senior research analyst at Russell Investments Canada Limited, who has interviewed and evaluated hundreds of investment managers during her career at Russell.

“The active managers we research expected 2010 to be more of a stock picker’s market and that’s exactly what’s developed so far. The view for the remainder of the year is that this positive environment will continue, although the month of April proved to be somewhat challenging. Only four sectors beat the benchmark and among the top-performers were energy and materials. Large cap managers have their largest underweights to energy and materials so strength in those sectors is hurting their benchmark relative performance. However, we all know that anything can change with two months to go in the second quarter.”

Wylie notes that the financials sector was a key contributor in the first quarter. The S&P/TSX Composite Index returned 3.1% but 80% of the return stemmed from the financials sector. Active managers in Canada are overweight the financial sector on average, which helped them beat the benchmark.

“In the first quarter, 7 out of 10 sectors beat the benchmark with the energy and materials sectors underperforming. Good sector breadth allows stock selection to drive manager performance. Add to that an environment where correlations of stocks are lower and active managers with skill in research and portfolio construction have the opportunity to be rewarded,” says Wylie.

Value managers edge growth managers

The report also found that 81% of value managers outperformed the S&P/TSX benchmark compared to 76% of growth managers. This was a significant increase in outperformance from the fourth quarter of 2009, when 57% of value managers beat the benchmark compared to 50% of growth managers.

The performance edge for value managers had more to do with stocks that they did not own, rather than stocks that they did own, Russell explains.

For instance, as the gold sector declined by 6.5% in the first quarter, growth managers had 10% of their portfolios in gold stocks. In comparison, value managers only had a 5% allocation to gold stocks — resulting in stronger performance relative to growth managers. In addition, the strength in the financials sector helped value managers who are overweight the sector on average, whereas growth managers tend to be underweight the sector by almost 3%.

“Canadian equity investment managers have been busy repositioning their portfolios with value managers moving out of the financials sector and reducing their overweight in the last year while growth managers have been moving into the financials sector and reducing their underweight positions,” says Wylie.

“This was the fourth consecutive quarter that value managers outperformed growth. While there are periods when one style dominates the other, over the long run they tend to have similar returns. However, since it’s impossible to forecast which style will outperform in the short term, the best approach is a well-diversified portfolio of multi-managers with complementary styles, so that investors can weather all types of investing environments,” Wylie adds.

Russell Investments Canada Limited is a wholly owned subsidiary of Frank Russell Company, headquartered in Tacoma, Wash.

IE