Investment Commentary – January 2012

You’re Not Alone

As those familiar oversized envelopes arrive in many an investor’s mailbox in the coming days and weeks, there will be some startling similarities across numerous investment statements. And it won’t just be the printed evidence of a flat or negative year for many equity products. Not only was market performance weak in 2011, but it was one of the weakest years for active management in more than a decade. That being said, it is important to remember that markets move in cycles and we could very well be poised to commence a period in which research and good stock picking are once again rewarded. We believe the tremendous risk aversion that seemingly protected some investors in the last market cycle might cause investors to lose out on market opportunities in the next cycle.

Performance across the Global Industry Classification Standard (GICS) sectors varied widely in 2011, with the strongest performance coming from some of the smaller more inconspicuous segments of the market, like utilities and healthcare. Every style will have its day in the sun, but we do not believe ourselves capable of accurately predicting these cycles and so continue to espouse a varied approach to client portfolios, with exposure to different asset classes, geographic regions, capitalization sizes, and management styles.

Source: Morningstar survey of 4,100 large-cap US mutual funds that track the S&P 500 Index

Obviously, underperformance of this magnitude is something we are paying close attention to, but the important takeaway is that any underperforming managers or funds in your investment portfolio are not an anomaly. At TEIC, we intend to closely examine this issue with our managers to ascertain whether or not the existing mandates and performance goals are still realistic and achievable.

It should also be pointed out that the data referenced here applies to large-cap US equity mutual funds, but it would not be completely without merit to extrapolate these results to investment products focused on other geographic regions. The results from Canadian equity managers encompassed a large deviation between sectors and even within sectors, although these deviations tend to diminish over time. The factors at play in the US were clearly present elsewhere, namely sizeable capital outflows coupled with flat yet highly volatile markets. Also at play were record high equity prices after nearly three years of earnings exceeding estimates and correlations on the rise as stocks moved en masse according to the headlines of the day. A particularly interesting statistic is that only 17% of those funds evaluated posted returns that actually beat their benchmark last year.