Q3 2024 Active Management Review: Market leadership reverses

by Gabriel Sauma, Russell Investments

Executive summary:

• Market leadership changed course during the third quarter, with the Low Volatility and High Dividend factors performing the best while the Momentum and Growth factors performed the worst. Smaller companies also generally did better than Larger caps.
• The third quarter was a more favorable environment for active managers in the UK, Japan, Europe, Australia, and Listed Infrastructure. It was a more challenging quarter for Global, Global ex-U.S., Emerging Markets, U.S. Small Cap, Long/Short strategies, and Global Real Estate managers. Active manager results in U.S. Large Cap were mixed.
• Interest-rate-sensitive sectors such as utilities and real estate were the best performers across most markets, with financials and consumer staples also performing strongly.

The third quarter of 2024 saw a clear reversal in market leadership, with the Low Volatility and High Dividend factors performing the best while the Momentum and Growth factors performed the worst. This was a stark shift from the first and second quarters of the year, when Momentum was the standout performer across all regions and Growth also performed strongly. The change coincided with relative weakness in the information technology (IT) sector. In another difference from earlier in the year, Smaller Caps generated positive returns across most markets, while the Value factor was more mixed but generally performed well.

Within Emerging Markets, country and sector positioning were more of a driver of performance than style, with the strong rally in China being a key determinant of manager relative returns as well as positioning in the IT sector. For Japan, Quality and Low Volatility were standout positive factors.

The third quarter ended up being a strong period for most equity markets, but it wasn’t without its twists and turns. Overall, it was dominated by three key events which contributed to overall market volatility. First, there was the unwind of the Japanese yen carry trade in early August, which resulted in a sharp selloff across most equity markets. Then, toward the end of the quarter, the U.S. Federal Reserve (Fed) delivered a supersized rate cut—its first cut in four years—which was quickly followed by China unleashing a wave of stimulus to stabilize its economy.

Overall, it was another positive quarter for most markets in local currencies, and even stronger for the U.S. dollar (USD), given the weakening in the greenback on underwhelming economic data as well as the big Fed rate cut.

On balance, the third quarter was a more favorable environment for active managers in the UK, Japan, Europe, Australia, and Listed Infrastructure, while being more challenging for Global, Global ex-U.S., Emerging Markets, U.S. Small Cap, Long/Short strategies, and Global Real Estate managers. Active manager results in U.S. Large Cap were mixed.

Interest-rate-sensitive sectors such as utilities and real estate were the best performers across most markets, with financials and consumer staples also performing strongly. In emerging markets, consumer discretionary was the best performing sector, supported by a recovery in Chinese names. Conversely, the IT and energy sectors were by far the worst performers across most markets.

Investors are increasingly of the belief that the U.S. will achieve a soft landing, which when combined with the Fed’s initial interest rate cut, drove positive sentiment during this period. This was reflected in the broadening of the equity market rally, alongside ongoing concerns from some managers about valuations and longevity of the tech rally. China’s largest wave of stimulus since the end of COVID-induced lockdowns was also a meaningful contributor to positive investor sentiment and market reversals.

In the short term, investors expect ongoing market volatility as the U.S. elections in November approach. Beyond that, the key risks remain an escalation of the current situation in the Middle East as well as the war between Russia and Ukraine.

At Russell Investments, our unique relationship with underlying managers affords us special access into the latest active management insights. Here are the key takeaways in third-quarter active management performance from our manager research team.

Global equities

The third quarter was a moderately favorable environment for active Global equity managers and more challenging for International strategies, with around 50% and 45% of products outperforming respective benchmarks.

• The third quarter saw the Value, High Dividend, and Minimum Volatility factors drive market returns, while the Momentum, Quality, and Growth factors lagged. This change, initially triggered by weak economic data in July, was an inflection point for markets. The big U.S. rate cut in September sent a strong message of policy support to the market.
• Cyclical and interest-rate-sensitive sectors such as real estate, financials, and materials subsequently rallied, while IT and communication services underperformed.
• Chinese equity markets also rallied strongly following the People’s Bank of China (PBOC)’s announcement of long-awaited stimulus to reinvigorate growth.

U.S. equities

The third quarter was a mixed environment for active U.S. Large Cap while being more challenging for U.S. Small Cap, with around 50% and 30% of products outperforming their respective benchmarks.

• Low Volatility and smaller caps outperformed in the quarter, as defensives and smaller cap companies led the market. Meanwhile, Quality and Growth underperformed as mega cap tech stocks lagged.
• Interest-rate-sensitive sectors like utilities and real estate were the top performers as the Fed began its rate-cutting cycle. Energy was the clear underperformer on weaker oil prices.
• While market breadth improved during the quarter, the lower concentration of returns was generally driven by sectors with reduced active manager activity, which hurt relative returns.

Emerging Markets equities

The third quarter was a challenging environment for active Emerging Markets managers, with around 25% of products outperforming the EM index.

• The unwind of the Japan carry trade in July, the Fed interest rate cut, and China stimulus in September set the stage for country, sector, and style performance.
• A reversal relative to the second quarter saw Momentum as the worst performing factor, with Low Volatility and Large Cap Growth performing strongly.
• Consumer discretionary, particularly in China, saw the strongest returns, while IT and energy lagged.
• China was the strongest large market performer, with the selloff in IT negatively impacting Korea and Taiwan.

UK and European equities

The third quarter was a favorable environment for active UK equity and European equity managers, with around 70% and 50% outperforming their respective benchmarks.

• Rate-sensitive areas of the market such as real estate and utilities benefitted from falling bond yields.
• Energy stocks struggled as oil prices retreated on concerns of reduced demand and increased supply.
• The UK marginally outperformed continental Europe. UK consumer staples stocks—particularly food retailers—benefitted from stabilizing inflation, which has helped improve consumer confidence.

Japan equities

The third quarter was a favorable environment for active Japanese equity managers, with around 70% of products outperforming the Tokyo Stock Price Index (TOPIX).

• The Bank of Japan's unexpected rate hike, along with a cautious outlook on the U.S. economy, lowered investors' expectations for both inflation and economic growth.
• Small and mid-caps and Quality and Low Volatility factors performed strongly in the quarter, while the Value and Momentum factors underperformed.
• The financials and utilities sectors also significantly underperformed, driven by a decline in inflation expectations. Conversely, consumer staples and healthcare performed strongly in the risk-off environment.

Australian equities

The third quarter was a moderately favorable environment for active Australian equity managers, with around 50% of products outperforming the ASX 300 Index.

• Expectations of interest rate cuts supported smaller companies, which typically have higher debt, as well as sectors which benefit from lower interest rates, such as IT and REITs (real estate investment trusts).
• Higher gold prices due to inflation and geopolitical concerns, plus expectations for a U.S. economic soft landing, supported materials companies. Energy companies underperformed in line with lower gas prices.
• Dispersion of quarterly returns within sectors was wider than usual, supporting a positive environment for active management.

Canadian equities

The third quarter was a challenging environment for active Canadian Large Cap equity managers, with around 35% of products outperforming the S&P/TSX Index.

• The Canadian stock market experienced a strong rebound, driven by interest rate cuts, with interest-rate-sensitive sectors such as real estate, financials, and utilities significantly outperforming.
• Low Volatility and, to a lesser extent, Value, outperformed the S&P/TSX Index while Growth and Quality lagged.

Long/Short equity

The third quarter was a challenging environment for Long/Short strategies, with the HFRI Equity Hedge Index advancing 3.8%, trailing the MSCI World Index. The HFRI Equity Market Neutral Index trailed the broader directional HFRI Equity index, advancing 1.2% as shorts were a headwind due to Q3’s market rally.

• Macro concerns (the upcoming U.S. election, anticipated Fed cuts, Middle East tensions) and an unexpected China stimulus in September caused increased volatility. This led to one of the largest de-grossing events in North American equities since 2016, as hedge funds reduced risk exposure.

Real estate and infrastructure

The third quarter was a favorable environment for active Global Infrastructure managers and challenging for Global Listed Real Estate managers, with around 85% and 30% of products outperforming respective benchmarks.

Real estate

• Interest rate declines benefitted interest-rate-sensitive sectors such as U.S. residential and lodging. Europe was one of the main beneficiaries, while Japan developers lagged.
• U.S. office was the best performing sector as the availability rate saw its first decrease since the fourth quarter of 2022. U.S. storage performed well, with expectations of rising housing transactions as rates fall.

Infrastructure

• Overweights to interest-rate-sensitive sectors, utilities, and towers were additive. Cyclically exposed sectors, including transport and energy midstream (pipelines), dragged on performance.
• UK utilities performed strongly, with improved expectations following the UK election adding to the tailwind from rate cuts.

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