For the second consecutive year, Canadian value investors outperformed growth managers. At QV Investors, we celebrate that as a value manager, but it’s hard to feel good about a year when rising inflation and interest rates along with geopolitical instability had such a negative impact on the markets across the board. Nobody wants to lose money. So, we take comfort in the fact that our risk-managed, disciplined approach led to a positive return of 3.1% in the QV Canadian Equity Fund in 2022, which was ahead of the S&P/TSX Composite Index return of -5.8%. Like many of our value peers, at QV, we define risk as the risk of capital loss and not whether we underperform a benchmark. However, benchmark-relative performance matters, particularly in the institutional space, so that’s why analysing the active management environment is important. One shouldn’t penalize a good manager because the active management environment is challenging or because their style of investing is out of favour. On the flipside, nobody wants to give too much credit to a portfolio that has done well simply because the active management environment is supportive or because its style is in favour.
CANADIAN EQUITY ACTIVE MANAGEMENT ENVIRONMENT IN 2022
A year ago, we introduced our analysis on the Canadian equity active management environment. We highlighted then that there is no scientific approach, but we consider a “favourable” active management environment to be when 50% or more managers in a universe beat the benchmark AND the median return is greater than the benchmark return. In 2022, the active management environment was strong for the second consecutive year with 78% of Canadian large cap managers (based on eVestment Canadian Large Cap and All Cap universes combined) beating the S&P/TSX Composite TR Index return. That’s up from 63% in 2021 and is the highest proportion of outperformance since 2015 when 85% beat the benchmark. In 2022, the median large cap manager return was -3.0%, which was ahead of the S&P/TSX Composite return by nearly 300 basis points.
Recall that 2019 and 2020 were challenging for active managers in Canada overall with less than 40% beating the benchmark in each year and median returns that lagged the benchmark.
VALUE MANAGERS BEAT GROWTH AGAIN
Let’s turn to a discussion of style. To keep this simple, we are only focusing on two styles: Value and Growth. Value managers are defined as those that seek to buy stocks that are trading at a discount to their “fair value” and sell them at or in excess of that value. Whereas growth managers are those that concentrate on companies with better prospects for future growth with less focus on valuation.
The chart below shows the last 10 calendar years and highlights how much of a comeback value managers have made in the last two years. In 2022, 83% of large and all cap value managers beat the S&P/TSX Composite TR Index, which is the highest since 2013. That’s up from 77% in 2020 and well above the 2018 to 2020 years when the value style of investing was clearly out of favour. The median value manager return of -0.9% was nearly 500 basis points ahead of the benchmark in 2022, also the highest since 2013.
How does that compare to growth managers? The chart below shows that 55% of growth managers beat the S&P/TSX Composite TR Index return in 2021, the same as in 2020. The median growth manager return was roughly 55 basis points ahead of the benchmark in 2021.
ANOTHER BIG DIFFERENCE MEDIAN RETURNS
The chart below brings the two styles together and shows the median large and all value manager return minus the median growth manager return since 2000. It’s clear from the chart how much value managers bounced back with the median return roughly 300 basis points ahead of the median growth manager return in 2022 after being 360 basis points ahead in 2021. Both years were the strongest since 2016 following three years when value was out of favour.
WHAT MIGHT HAVE HELPED VALUE MANAGERS
Last year in this report, we highlighted how the concentrated nature of the Canadian market is often more problematic over short periods of time for value managers than growth managers. Like most value managers in Canada, QV not owning Shopify hurt the benchmark-relative performance for three consecutive years, most notably in 2020 when the stock briefly became the largest in the index. That all changed in 2022 when the stock fell nearly 73%, so not owning it added roughly 430 basis points relative to the benchmark.
We all know that no one style of investing consistently outperforms in Canada and at times the differences can be quite extreme. Now that we’re two years into the value cycle, the big question is how long will this outperformance last? It’s impossible to forecast but style cycles tend to last 3 or 4 years so there is quite a bit of optimism surrounding value investing. At QV Investors, we’re not forecasters so our approach has always been to focus on holding a diversified portfolio of quality companies that are trading at attractive valuations. That’s how we add value over the long run.
While it’s impossible to predict which style will be in favour and for how long, the turnaround in value after lagging for three years is certainly worth noting. No one style consistently outperforms in Canada and at times the differences can be quite extreme. Typically, but not always, style cycles last 3 to 4 years. With interest rates poised to rise, perhaps value investing is the place to be.
All returns stated are gross of fees.