Hip hip hooray! After lagging growth managers for three consecutive years, value investors in Canada were back in favour in 2021. Of course, we’re celebrating this at QV Investors given our focus on quality and value. The QV Canadian Equity Fund produced strong absolute and relative results, returning 28.9% in 2021 versus the benchmark return of 25.1%. But before you dismiss this as marketing propaganda, let me shift focus to the broader active management environment in Canada. Understanding the active management environment provides important context to investment manager performance. 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 just because the active management environment is supportive or because its style is in favour.
SOME HELPFUL DEFINITIONS
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 2021, 63% of Canadian large cap managers (based on eVestment Canadian Large Cap and All Cap universes combined) beat the S&P/TSX Composite TR Index return, which may not sound that impressive but is a notable improvement from 38% in 2020 and is the highest proportion of outperformance since 2015 when 85% beat the benchmark. As well, the median large cap manager return was 26.3% in 2021, roughly 120 basis points ahead of the S&P/TSX Composite TR Index return of 25.1%. Looking back, 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.
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.
VALUE MANAGERS BEAT GROWTH
The chart below shows how much of a comeback value managers made, with 77% beating the S&P/TSX Composite TR Index return in 2021. That’s up from 32% in 2020 and is the highest since 2013! The median value manager return was over 4% ahead of the benchmark in 2021, 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.
HUGE DIFFERENCE IN MEDIAN RETURNS
The chart below brings the two styles together and shows the median value manager return minus the median growth manager return. It’s clear from the chart how much value managers bounced back with the median return roughly 360 basis points ahead of the median growth manager return. That’s the most since 2016 and follows three years when value was clearly out of favour.
WHAT MIGHT HAVE HELPED VALUE MANAGERS
The concentrated nature of the Canadian market is often more problematic over short periods of time for value managers than growth managers. RIM (now Blackberry), Valeant (now Bausch Health Companies) and Nortel are historical examples of this. Most recently it has been Shopify. Most value managers do not own Shopify so when it was up 178% in 2020 and became the largest stock in the index, it really hurt value managers’ benchmark relative performance, particularly those with concentrated portfolios. Just to give some perspective, not owning Shopify in the QV Canadian Equity Fund detracted over 500 basis points of excess return in 2020. In 2021, Shopify’s 30% surge in the second quarter also had a negative impact, but not owning it had a neutral to slightly positive impact on benchmark relative performance throughout the rest of the year. Note that for the month of January in 2022, not owning Shopify added over 200 basis points of excess return with the stock down nearly 30%.
Gold stocks have also had a significant impact on the active management environment in Canada over time. After surging almost 22% in 2020, gold stocks fell nearly 10% in 2021, which was hugely beneficial for value managers who tend to have no or very little weight in gold compared to growth managers. Not owning any golds in the QV Canadian Equity Fund added over 300 basis points of excess return in 2021, after detracting nearly 120 basis points in 2020.
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.