DFEV - Q3 2023 Active Management Review: Value Dominates

2023-11-08 23:36:00 ET

Summary

• The third quarter was a more favorable environment for active managers in U.S. Large and Small Caps, Japan, Australia, and Canada equities, while being more challenging for Global, Global ex-U.S., Emerging Markets, Europe, UK, and Long/Short managers.
• The Value factor dominated returns across all regions, while Growth was the worst-performing factor.
• The energy sector was the best-performing sector for equity managers, generating meaningful positive returns across all regions.

The debate over Value stocks versus Growth stocks has raged for the better part of the last decade among investors, especially due to Growth's unprecedented run since the Global Financial Crisis ((GFC)). This was not the case during a volatile third quarter, however, as the Value factor dominated returns among active managers across all regions. On the contrary, Growth was the worst-performing factor. Quality provided defensiveness in the U.S. market, while Low Volatility offered better downside protection in other markets outside of the U.S.

On balance, the third quarter proved to be a more favorable environment for active managers in U.S. Large and Small Caps, Japan, Australia, and Canada equities, while being more challenging for Global, Global ex-U.S., Emerging Markets, Europe, UK, and Long/Short managers. The volatility of the quarter meant that divergence in country, style, and sector returns all impacted managers' index-relative returns, with stock selection also being key.

Sector-wise, energy was by far the best-performing sector, generating meaningful positive returns across all regions. Financials also outperformed in most markets, although to a lower degree. This dynamic supported the outperformance of Value during the period. Conversely, utilities and consumer staples were among the weakest sectors across markets. Information technology, which had previously benefited from the generative AI (artificial intelligence) theme throughout most of the year, also underperformed.

Australian equities

The third quarter was a favorable environment for active Australian equity managers, with around 55% of products outperforming the ASX 300 index.

• Stock selection, rather than sector or factor exposure, drove relative returns. The wide dispersion of stock performance within sectors powered the impact of stock selection.
• Overweights to energy stocks contributed on the back of higher oil prices, while the outperformance of banks was a headwind for most strategies.
• The healthcare sector underperformed meaningfully, largely driven by the fall in CSL (CSLLY) and Resmed (RMD) due to higher interest rates, impacts of GLP1s (Ozempic), and earnings downgrades.

Canadian equities

The third quarter was a favorable environment for active Canadian large-cap equity managers, with around 60% of products outperforming the S&P/TSX Index.

• Energy was the strongest sector in the S&P/TSX Composite Index, driven by the increase in oil prices. Communication services and utilities were the biggest underperformers.
• While an underweight to energy hurt the average manager, underweight to utilities and materials was beneficial.
• Shopify (SHOP) was down 13.4%. With most managers underweighting the large benchmark constituent, it was a significant contributor to managers' excess returns.

Emerging markets equities

The third quarter was a challenging environment for active emerging markets ((EM)) managers, with around 35% of products outperforming the Emerging Markets Index.

• Country dispersion was again a meaningful driver of returns. India continued its strong run while China outperformed despite negative sentiment, driven by positive returns within the consumer discretionary sector. Korea and Taiwan experienced a downward correction, having been strong year-to-date performers due to the AI theme.
• Large Cap Growth underperformed on concerns of higher-for-longer interest rates, while Value and Small Caps both fared better, continuing their strong runs year-to-date.
• Energy was the standout performer with higher oil prices, while the IT sector lagged.

Europe and UK equities

The third quarter was a challenging environment for active European equity and UK equity managers, with roughly 45%outperforming respective benchmarks.

• Energy stocks led the way, supported by a rise in oil prices. However, this dynamic also resulted in renewed concerns of pressure on consumers, leading to underperformance for both the consumer discretionary and consumer staples sectors.
• Benchmark composition led the UK market to outperform continental Europe, given its skew toward energy, whereas the latter has high exposure to luxury and semiconductors.

Global equities

The third quarter was a moderately challenging environment for active International and Global equity managers, with around 45% of products outperforming their respective benchmarks.

• After an initial growth-led rally in 2023, Value stocks proved more resilient during the third-quarter selloff. Value, Income, Minimum Volatility, and Quality exhibited downside protection while Growth struggled.
• Energy outperformed, with rising oil prices due to production cuts from key OPEC producers, e.g., Russia and Saudi Arabia.
• Continental Europe lagged due to high energy costs. Cheaper-valued markets such as the UK and Japan were less negative.

Japan equities

The third quarter was a moderately favorable environment for active Japanese equity managers, with around 50% of products outperforming the TOPIX index.

• Value was the best-performing factor, benefiting from the macro backdrop and government drive for better governance. Meanwhile, Quality and Growth lagged.
• The energy and financials sectors rose sharply, benefiting from higher oil prices and persistent inflationary pressures, respectively. Conversely, the information technology sector underperformed.
• The Small Cap universe outperformed the Large Cap universe for the first time since the second quarter of 2022, but there was a large dispersion between Small Cap Value and Small Cap Growth.

Long/short equity

The third quarter was a challenging environment for equity long/short strategies, with the HFRI Equity Hedge index returning -0.97%.

• Monetary policy shifts, especially interest rate hikes, significantly swayed investor sentiment and equity market performance globally.
• Sector performance varied, with energy stocks rising amid oil production cuts, while IT sector declines were driven by consumer spending concerns.
• Economic data like unemployment rates and PMI indices, which indicated economic cooling or contraction, influenced investor optimism and market trends across all regions.

U.S. equities

The third quarter was a favorable environment for active U.S. large-cap and U.S. small-cap managers, with around 60% of products outperforming their respective benchmarks.

• Quality and Low Volatility outperformed in the quarter, while High Dividend Yield underperformed in the wake of higher interest rates providing a more competitive alternative.
• Energy names were the standout outperformers, while bond proxy names in utilities, real estate, and consumer staples lagged the wider market.
• Outside of more Value-oriented strategies, Small and Mid-caps continued their multi-year trend of underperformance against Large Caps in the quarter.

Real assets

The third quarter was a favorable environment for active Global listed real estate managers while being more challenging for Global infrastructure managers, with around 80% and 15% of products outperforming their respective benchmarks.

• Global Real Estate mainly generated alpha from stock selection within sectors made possible by the wide dispersion of returns (e.g., U.S. healthcare had returns ranging from +20% to -40%).
• In infrastructure, higher interest rates were a headwind across most sectors and most stocks within a sector (especially utilities). Non-benchmark bets in cell towers (rate-sensitive due to long-dated leases) also contributed to negative excess returns.

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