Active managers beat benchmark in Q4: Russell

“The focus came back to fundamentals, with many of the companies that were beat up in the third quarter rebounding strongly in the fourth, primarily in the month of October,” says Kathleen Wylie, senior research analyst at Russell Investments. “The market seemed to recognize that good companies, with good management, trading at reasonable valuations, should be rewarded.”

Wylie points out that many of the top-contributing stocks in the fourth quarter had experienced significant declines in the third quarter when the market focused almost exclusively on macro factors. For example, the top-contributing stock was Canadian Natural Resources, which rose 24% in the fourth quarter after falling 24% in the third. As well, Royal Bank of Canada was a top contributor in the fourth quarter, up nine percent after falling 12% in the third quarter. Other examples of similar situations include Canadian National Railway Co. and Suncor Energy Ltd.

“These are among the most widely held names by Canadian equity investment managers,” notes Wylie, “so their strong rebound in the fourth quarter had a significant positive impact on manager returns. More than 70% of the investment managers we research hold Canadian Natural Resources, Canadian National Railway and Suncor, and more than 80% hold Royal Bank, so those stocks were key factors in the strong active management environment.”

“It was also a case of what managers didn’t own that helped them beat the benchmark in the fourth quarter,” says Wylie. “Gold stocks fell in the fourth quarter, and large cap managers on average were almost six percent underweight gold stocks at the start of the quarter. So the decline really benefited their benchmark relative performance.” Kinross Gold was the largest negative-contributing stock in the benchmark index, falling 25% in the fourth quarter. However, only 29% of large cap managers held the stock. Agnico-Eagle was the second-largest negative contributing stock, falling 41% in the fourth quarter, but was held by only 14% of large cap managers.

Research in Motion was also a key negative contributor in the fourth quarter, falling 31%. Wylie notes that active managers have been moving out of the name, but RIM was still owned by 44% of investment managers at the start of the fourth quarter. “At the end of 2010, 66% of large cap managers held RIM so that shows how quickly the tide can change,” she says.

Sector positioning had little impact on manager performance in the fourth quarter generally, with large cap managers on average favourably positioned in only four of the 10 sectors. “This highlights that it was all about stock-picking, which is what we believe is the key driver of performance in the long run,” Wylie says.

All styles of large cap managers beat the benchmark in the fourth quarter. For the third consecutive quarter, dividend-focused managers were rewarded most, with 94% outperforming the S&P/TSX Composite, followed by 75% of value managers and 59% of growth managers. Those numbers are higher than in the third quarter when 74% of dividend-focused, 30% of value, and only 12% of growth managers beat the benchmark.

Stock picking still expected to be key in 2012

The S&P/TSX Composite has kicked off the year on a positive note, up almost five percent in the first four weeks of the year. “Active managers are optimistic that stock picking will continue to be rewarded,” says Wylie. “Many companies that are profitable with solid earnings growth are trading at attractive valuations.”