The year began on a positive note for active Canadian equity managers, who found it a more favourable environment for investing compared to the last couple of years, according to Russell Investments Canada’s first quarter 2007 report on active management.

“In the first quarter of 2007, 65% of large-cap equity managers in Canada outperformed the S&P/TSX composite index, which is the highest proportion in almost three years. That was up from the fourth quarter of 2006 when just 51% beat the benchmark,” said Kathleen Wylie, senior research analyst, Russell Investments Canada.

The median large cap manager posted a return of 3%, which was ahead of the S&P/TSX Composite return of 2.6% in the quarter.

“We started this survey of over 120 active, Canadian fund managers over three years ago. At Russell we monitor all managers due to our multi- manager approach to investing and use this information to provide details on ongoing results to our own internal fund managers,” added Wylie.

There was more breadth in the market in the first quarter with five of the 10 sectors outperforming the index and a narrower gap between the best and worst performing sectors.

“Telecommunication services had the highest return, up 7.9% compared to the lowest returning sector, utilities, which fell 5.8% in the first quarter,” said Wylie. “Active managers generally were positioned favourably in both those sectors with the average large cap manager slightly overweight Telecommunications and underweight utilities.”

At the individual stock level there was more breadth with 50% of the names in the S&P/TSX composite beating the index return of 2.6% in the first quarter, but with less dispersion between stock returns. This made it more challenging for active managers to stand out, relative to their peers, in the quarter. The result was a notably tighter range between the top-performing large cap investment manager and the bottom-performing investment manager. The 7.6% difference was the lowest in four years.

Although the overall environment was better than recent periods, there still continued to be headwinds for active managers. First, the high level of mergers and acquisitions activity hit record levels in late 2006. And second, high levels of liquidity in the economy generally have fuelled a surge in private equity interest in some lower quality companies, which are not typically widely held by large cap investment managers.

In terms of investment style, the environment was more conducive for value managers, with 71% of them outperforming the benchmark in the first quarter of 2007, compared to 61% of growth managers. That was a reversal from the fourth quarter of 2006 when the majority of growth managers beat the benchmark compared to only 27% of value managers.

In the first quarter of 2007, value managers were helped by more positive positioning compared to growth managers in three of the top four performing sectors: industrials, consumer discretionary and financials. It also helped that value managers were more underweight the heavily-weighted energy sector, which lagged the benchmark return.

Added Wylie: “Generally, value managers have struggled more than growth managers in the last couple of years with the strength in resources. In 2005, value managers tended to be more underweight the top-performing energy sector and similarly in 2006, they were underweight materials on average.”

Small-cap stocks were more rewarded in Q1 2007 compared to the broader S&P/TSX composite. The S&P/TSX small-cap index posted a return of 6% in Q1 compared to 2.6% for the composite. The median small cap manager return was also 6%, which was double the median large cap manager return.
“Similar to large cap space, the range in returns between the top- and bottom-performing small cap managers was narrower compared to history,” said Wylie. “Generally, during the resource run of the last two years, small cap stocks have been more rewarded which has helped small cap investment managers to outperform large cap.”