Only 41% of large cap Canadian equity investment managers beat the S&P/TSX composite index in the fourth quarter of 2007, the lowest number in over two years, according to the latest Russell Active Manager Report.

Active managers were mainly hurt by having significant underweight positions in the energy and materials sectors, which were two of just four sectors that beat the S&P/TSX composite in the fourth quarter.

It was a challenging year overall for active managers, with the median large cap manager return of 9.6% lagging the S&P/TSX composite return of 9.8%. The last year the median manager lagged the benchmark was in 2005, when the energy sector dominated and most large cap Canadian equity managers were underweight the sector.

“It’s unusual to see the median manager trail the benchmark. But keep in mind that active managers have historically added value over the long run,” says Kathleen Wylie, a senior research analyst at Russell Investments Canada.

The good news, according to Wylie, is that the increased market volatility in the equity markets can be a positive for active managers and a potential boon for investors’ portfolios.

“The increased volatility in the stock markets allows active managers with skill to add more value over the benchmark. For instance, the range in returns between the top- and bottom-performing stocks in the fourth quarter of 2007 widened out to the highest level in almost two years stemming from the volatility. This led to a wider dispersion of returns between the top- and bottom-performing large cap managers of almost 20% — also the highest in almost two years,” says Wylie.

“The expectation is for volatility to continue this year, which could make 2008 a more favourable environment for active managers. This means that portfolios that feature highly-skilled managers that are able to add value over the benchmark have more potential for impressive returns,” Wylie ads.

Last year also saw the worst performance by value managers since 1999. Only 16% of value managers beat the S&P/TSX composite index in the fourth quarter. In contrast, 53% of growth managers outperformed the benchmark. Although this result was not as extreme as in the third quarter, there continued to be a significant divergence between the performance of growth and value managers.

Russell Investment Group advises institutional clients with total assets of over $2 trillion and manages approximately $225 billion in its investment management business.