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Q3 Financial Update: Active managers finish ahead of their benchmarks

Q3 Financial Update: Active managers finish ahead of their benchmarks


“The goal of any investment manager,” to quote investopedia.com, “is to outperform a designated benchmark.”  And this quarter we’ve seen that active management – where the investor chooses what makes up the portfolio to try to “beat the market” – posted decent results against a backdrop of falling stock and bond markets.

U.S. Equities: A tailwind for active managers?

Within U.S. equities, active managers outperformed across the value categories comprised of companies that are currently trading below what some investors think they are really worth and can potentially provide a superior return. Fund managers also outperformed in the small and mid-cap blend categories, valued between $300 million and $10 billion, but they did not fare as well in large and mid-cap growth categories.

The table below lists the relative ranking of the Russell indices* within their relevant mutual funds categories as reported by the independent research firm Morningstar:

Category Index rank
Large Blend 45
Large Growth 38
Large Value 67
Mid Blend 70
Mid Growth 43
Mid Value 71
Small Blend 77
Small Growth 69
Small Value 59

Source: Morningstar

*Russell indices comprise approximately 93% of the total market capitalization of all listed stocks in the U.S. equity market

Key takeaway

It’s challenging to draw conclusions about what worked and what didn’t when individual managers take so many different approaches. All of these indices posted negative returns for the quarter.  However, because active managers  have the ability to raise cash rather than investing in the market, they ought to have a bit of an advantage against the benchmarks, but that can be offset by management fees. 

Large cap growth has been a difficult space for active management over the last decade. The percentage of managers outperforming the benchmark has declined as the index has grown more concentrated (the five largest stocks comprise more than 37% of the Russell 1000 Growth index). Despite large losses in the two largest positions – Apple (-11.6%) and Microsoft (-7.1%) – the index was only down -3.13%.

On the other hand, with the Russell 2000 down -5.13%, active managers had a much easier time competing against that index and managers who dipped down into micro-cap stocks or favored higher quality companies tended to perform better than the index.

International Equities: International managers faced headwinds

International equity managers had a difficult environment and the table below lists the relative ranking of the Morgan Stanley (MSCI) indices within their relevant Morningstar categories:

Category Index rank
Foreign Large Blend 28
Foreign Large Growth 45
Foreign Large Value 15
Foreign Small/Mid Blend 10
Foreign Small/Mid Growth 21
Foreign Small/Mid Value 40
Diversified Emerging Mkts 43

Source: Morningstar

Key takeaway

International managers struggled against their relevant benchmarks, especially international large value and international small/mid blend funds. However, managers with heftier allocations to Japanese and/or emerging markets stocks generally performed better than others. Both MSCI Japan and MSCI Emerging Markets beat the MSCI EAFE (non-U.S. and non-Canadian equity markets) and MSCI All Country World Index (excluding the U.S.) indices over the third quarter. But since both Japan and Emerging Markets have been challenging places to invest over the last decade, allocations to these areas are frequently smaller than index weight.

Fixed Income: Active managers the front runner?

Within the fixed income universes, active management outperformed solidly. The table below lists the relative ranking of the appropriate bond indices within their relevant Morningstar categories:

Category Index rank
Intermediate Core  62
Intermediate Core Plus 70
US High Yield 51
Global Bonds 56

Source: Morningstar

Key takeaway

There are two primary levers of fixed income returns: interest rates and credit. In general, active managers usually have more credit exposure than the benchmark. When credit performs well relative to the index, as it did in the third quarter, active managers usually outperform. And managers carrying shorter durations than the benchmark, as many currently do, outperform in a rising rate environment. It will be interesting to see how rates move in the fourth quarter, as numerous managers have talked about adding duration now.

Into the home stretch

In conclusion, active management turned in a respectable quarter, and finished ahead of their benchmarks in most U.S. equity and fixed income categories. International equities proved quite challenging, though and we’ll be watching with interest to see if active management can improve upon this quarter’s results to finish the year strong.


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