Where equity managers see opportunity now

For roughly 18 months now, public equities have been among the best performing asset classes for all investors. After a decade where private equity and other alternatives grabbed headlines and attention, returns from equity markets — especially US equity markets — have outpaced almost any other asset class. But after, or during, a strong run many advisors and investors are left wondering where opportunities are out there now.

That was the key question asked a panel discussion at the Canada Pension and Benefits Institute Forum held earlier in June. Bryan Pilsworth, President & CEO, Portfolio Manager – Canadian Equities, Foyston Gordon & Payne, Dimitar Shapov, Portfolio Manager of our Emerging Markets Equity strategy, Burgundy Asset Management Ltd, and Peter C. Fisher, Senior Managing Director, Partner, and Equity Portfolio Manager, Wellington each offered insights into the state of equity markets now, what brought us to this point, and where investors may be able to find opportunities or see risks going forward.

The panel highlighted a wide range of themes, including the rise of US equities and how investors can deal with the resulting concentration risks. They also highlighted some opportunities in Canadian markets, namely in Canadian resource extraction. Perhaps one of the consensus points that emerged from the panel was on the growing value of active management in this environment.

“We’ve seen a dramatic expansion in market valuations. Earnings have grown nicely, but on top of that overall returns for equity markets have been higher…we’ve recently seen valuations go into the teens and this has happened because valuations are expanding,” Fisher said at the panel. “That is actually good for passive investors, but the question is whether that will continue in the future? it’s reasonable to entertain the idea that markets may revert to some degree, and I think that will mean active management will look much more valuable to investors in the next 5-10 years than it has been in the last decade.”

Shapov added that in the realm of emerging market equities, active management has even greater potential for value generation. The inefficiencies present in those markets, as well as the economic factors such as geopolitical uncertainty and idiosyncratic risks can give knowledgeable active managers an advantage.

The panel also highlighted that the broad trend towards passive management could create new opportunities for active managers. As a higher percentage of total assets are allocated towards index-tracking investments, the opportunity for alpha generation through active management rises.

With the recent run in equity markets has come some significant leadership from US equities. In highlighting global equity opportunities the panel paid some significant attention to the global importance of US equities, and contrasted them with what opportunities are out there in Canadian stocks.

“It’s hard to argue against the Untied States and their capital markets, these are the deepest capital markets in the world and a breadth of companies greater than pretty much any jurisdiction in the world,” said Bryan Pilsworth. “The US provides us with a kind of a benchmark that is really important, but the US isn’t the only market in the world…I don’t think a good investor should be myopically focused on the US being the only place you can generate alpha returns.”

Pilsworth advocates for looking at the US as a basket of quality and then looking at other countries for companies that offer similar qualities with perhaps more attractive valuations. The wider panel noted that nobody had fully predicted just how much US equity markets would outperform, they also highlighted some of the concentration risk that now emerges as a small subset of US tech stocks dominate the overall mix of the S&P 500.

Canadian stocks came up in the conversation, too, in the context of contrasting opportunities with the US market as well as ESG implications. Pilsworth noted that for mining and resource extraction, Canada has a business environment not unlike silicon valley, as a center for venture capital to find mining companies. Moreover, Fisher highlighted that Canadian miners and resource extractors are extremely efficient and come with a greater degree of ESG adherence than many other similar names globally.

The panel was also asked about the place of private equity in portfolios, whether the asset class has lost its shine in this market. While the panellists all agreed that diversification and some private equity exposure is important, it lacks the significant appeals in this environment that it did some years ago.

“People forget about liquidity and the advantage of liquidity,” Shapov said. “Two reasons why private equity has become more difficult is that you have less transparency and you have the illiquidity. For example, if you had investments in Russia before the war during the two week period when it was going to happen, if you were in public markets you could exit. But if you’re in private equity, what do you do?”