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These Active Managers Have Shined During the Downturn

Small-cap value managers beat their benchmarks by the largest margins in the second quarter and over the year to date, according to data from Investment Metrics.

Among all types of active managers, those who invest in small-cap value stocks have done the best job navigating the market turmoil.

Small-cap value managers generated average excess returns of 2 percent in the second quarter, 2.1 percent for the year to date, and 5.4 percent over the trailing 12 months, according to data from Investment Metrics, which was acquired by Confluence in November. They were the strongest performer among all active style peer groups in each time frame, based on their performance against the Russell style indexes.

The outperformance of small-cap value managers can be largely attributed to a market environment that’s conducive to value stocks. In the second quarter, all sub-factors in the value category outran the benchmark, according to IM’s most recent factor performance report. Large-cap value managers also generated positive value for investors with an average outsized return of 0.4 percent in the second quarter, 0.7 percent for the year to date, and 1.2 percent over the trailing 12 months. 

In comparison, the performance of growth managers is disappointing. Most growth sub-factors lagged the benchmark in the second quarter as persistent inflation and mounting recession fears challenged the health of the U.S. economy, according to IM’s factor performance report. Over the past 12 months, all growth managers underperformed their benchmark by an average of 7.9 percent. When it comes to small-cap growth strategies, these funds have underperformed over the most recent quarter and six-month periods, but have delivered excess returns of 2.9 percent over the last 12 months. And small-cap growth strategies still top all other peer groups over the last three years, with an average outperformance of 4.8 percent, thanks to the strong growth momentum before 2022. 

Beyond a favorable market for value, small-cap value managers have also derived success from focusing on fundamentals and taking a more active investment approach. According to Brendan Cooper, senior consultant at IM, the top performing small-cap value managers tend to invest in a smaller amount of companies after conducting thorough research on each holding. Compared to systematic investors who rely on quantitative metrics, these fundamental managers usually have more concentrated portfolios.  

“If there’s volatility in the market, I think that is a chance for active fundamental managers to shine and improve their stock picking ability,” Cooper said. “It’s one thing when the markets are all moving in the same direction — it’s sort of like rising tide raises all ships — but when things get choppy... a little bit more defensive-tilted fundamental managers tend to be the ones that do add value.”

For small-cap value managers in the top quartile, 96 percent of them had high active share and 86 percent used fundamental research in their portfolios, according to IM. Half of them also had exposure to the quality factor, while only 14 percent used a quantitative investment approach. Cooper said that some quantitative managers with a focus on low volatility have also done well in the current market. 

“We’ve been in an environment where there’s certainly been more pressure for managers to demonstrate they are more active or [able to] take bigger bets and have more convictions,” Cooper said. 

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