As the Canadian stock market regained a considerable amount of lost ground through the final months of 2002, the average active Canadian equity manager of most investment styles fared poorly against their benchmarks in the fourth quarter.

“After three generally successful quarters, active managers had a tough go during the fourth quarter as the stock market recovered some of its earlier losses,” said Paul Carter, manager research analyst at Frank Russell Canada.

In Canada, the S&P/TSX Composite Index returned a solid 7.5% in the quarter, mitigating the year’s loss to just over 12.4%, slightly better than the year before which saw the index post a -12.6% return. The average large cap Canadian equity manager returned 6.7% in the fourth quarter, which is a significantly better return than in the previous three quarters of 2002. However, less than 40% of active managers in Canada beat the S&P/TSX 300 Index.

The extraordinary turnaround performance of the Information Technology sector during the fourth quarter (+43%), and Nortel Networks in particular (+219%) were the primary reasons for the difficulty active managers experienced, as the vast majority of them held underweight positions in both this sector and stock.

However, for the calendar year Canadian equity managers’ collective underweight position to the Tech sector was a positive, given its poor performance for the year (-65%). An amazing 70% of active managers beat the S&P/TSX, with the median manager return (-9.0%) bettering the Index by almost 3.5%.

On average, both growth and value equity managers ended the fourth quarter with roughly similar returns. Most value managers posted a return between 3% and 12% or the quarter, with the median value manager returning 7%.

Meanwhile, growth manager returns ranged between 1% and 12%, averaging 6.1%. While growth managers did tend to hold greater positions in some of the top-performing Technology stocks than did value managers, growth manager returns were hurt by relatively large positions in energy stocks such as Suncor (-9.6%) and Encana (+1.6%).

Small cap stocks outperformed their larger cap counterparts in 2002. The S&P/TSX SmallCap Index, which includes stocks between roughly $150 million and $1 billion in market capitalization, returned -3.5% versus the S&P/TSX Composite’s return of -12.4%. However, small cap stocks fell short in the fourth quarter, underperforming larger cap stocks by 4.5%.

Small cap investment managers had a relatively easy time exceeding the small cap index’s return in the quarter, with the average manager returning 4.5%. For the year, 80% of active small cap managers beat the benchmark, with the median manager returning a solid, if unspectacular 1.1%.
The fourth quarter proved to be rewarding for active Canadian fixed income managers, with 62% of the 52 members in the Frank Russell Canadian Fixed Income Universe outperforming the Scotia Capital Universe Bond Index. The median manager outperformed the index by 4 basis points, with the average manager outperforming by 8 basis points.

For the calendar year, only 51% of active fixed income managers beat the Scotia Capital Universe Bond Index. Challenges faced by bond investors over the year included an uncertain economic recovery and heightened corporate bond volatility, highlighted by the increased ratings downgrades in telecommunications bonds.

On a forward looking-basis, the tone from most active Canadian investment managers is cautiously optimistic for the economy, according to a consensus of Russell’s research analysts who continually monitor and intensely research 3,400 manager products worldwide.

The reason often cited for the optimism is the delayed effects of the central bank’s stimulatory monetary policy, while managers believe caution is warranted due to the geopolitical risks present. Given the low interest rates currently available in the bond market, many fixed income managers are moving towards reducing duration exposure while maintaining a bias to corporate bonds. A

s many equity managers believe improved economic performance will translate into above-average returns in 2003 from the more economic-sensitive stocks, they have been increasing their weights in some of the more cyclical industries such as Metals & Mining, Chemicals and Semiconductors.