The extreme market environment in the third quarter of 2008 highlighted the strengths of active management with 65% of large cap Canadian equity active managers beating the benchmark.

This was up from 41% in the second quarter, up from 20% in the first quarter, and the highest since the first quarter of 2007, according to the Russell Investments Active Manager Report.

In comparison, Russell found that, on average, 54% of active managers have historically beaten the benchmark over the nine-year period in which data has been collected.

The S&P/TSX composite index return was negative 18.2% in the third quarter, but the median large cap manager returned negative 17.2%.

It was a quarter of reversals with the energy and materials sectors among the worst performers, after being the best performers a quarter ago, and financials was the only sector to show a positive return.

“Active managers on average were underweight energy and materials and slightly overweight financials, helping them beat the benchmark after lagging for four consecutive quarters. Managers benefited from more breadth in terms of sector performance with seven out of 10 sectors beating the benchmark,” says Kathleen Wylie, senior research analyst at Russell Investments Canada Ltd.

“If you look at the actual sector returns, however, the difference in returns between the top-performing financial sector and the bottom-performing information technology sector was over 40%, which was the widest in almost six years. That led to a much wider difference between the top- and bottom-performing investment manager return in Canada of an astonishing 36%, the widest in almost nine years when we were in the middle of the technology bubble,” Wylie says.

After struggling for most of the last three years, an astounding 93% of value managers in Canada beat the benchmark in the third quarter compared to just 27% of growth managers. That compares to just 12% of value managers and 81% of growth managers in the second quarter. The median large cap value manager return was negative 12.9% compared to the median growth manager return of negative 20.9%.

“I have not seen that much of a difference in returns between value and growth managers since the first quarter of 2001 when value managers beat growth by almost 11% as they benefited from not owning Nortel when that stock was plunging,” says Wylie.
At the stock level, value managers were helped more by what they did not own than what they owned.

“The largest negative contributor to the S&P/TSX Index return in the quarter was Potash Corp. of Saskatchewan and very few value managers held the stock while the majority of growth managers held it and had overweight positions. Potash fell 42% in the third quarter after gaining 185% in the one year period prior to the third quarter,” says Wylie.

“The same can be said for Research in Motion, with only a couple of value managers holding the stock but the majority of growth managers holding it at an overweight on average. RIM fell 41% in the third quarter after rising 67% in the one-year period ahead of the quarter.”

Looking ahead to the fourth quarter

“As the volatility extended into the fourth quarter, it is impossible to predict which style will outperform. Everything is changing so quickly. It still looks like there is breadth in terms of sector returns, with only energy and materials lagging the benchmark return and financials somewhere in the middle. Value managers tend to have their largest overweights to financials, consumer discretionary and consumer staples stocks whereas growth managers have their largest overweights to industrials and information technology,” says Wylie.

IE