Equity Markets
Market Canadian International
Specialized portfolio
Canadian Equity U.S. Equity
(hedged and unhedged) Foreign Equity (hedged and unhedged) Emerging Markets Equity Québec International Management type Active Internal Active Internal and external Index Internal Active Internal and external Index Internal Active Internal and external Active Internal and external Management approach
Discretionary Discretionary and systematic (external) Discretionary and systematic (external) Discretionary Discretionary and systematic Main analytical approach Fundamental Bottom-up Fundamental Bottom-up Fundamental Bottom-up Fundamental Bottom-up and top-down Fundamental Bottom-up and top-down
Investment horizon 0 to 3 years
Main management styles and investment strategies Core Long Core Long/short Core Long/short Directional Long Long/short (equity) Directional (bonds)
Specialized portfolio management by the Equity Markets group
Market review
Corporate earnings were up sharply in 2005, occasionally even exceeding investor expectations. The global markets therefore recorded excellent performances. Still, the threat of sustained interest rate hikes and the financial imbalances in the United States hindered the progress of the U.S. stock market, which significantly underperformed the other markets.
Global growth was dominated by low interest rates, vigorous emerging markets and investor appetite for basic materials and energy. During the year, the price of crude oil reached a record US$70.85 a barrel.
The energy sector, which was up a spectacular 63%, con- tributed 50% to the 24.1% return on the S&P/TSX Capped Index in 2005. All the other sectors, excluding utilities, underperformed the index.
Overall return and specialized portfolio analysis
Depositors’ net assets in the group’s portfolios totalled $44.8 billion as at December 31, 2005 (Figure 32), up $3.9 billion in relation to 2004.
The Equity Markets group’s overall return in 2005 was 17%, or 94 b.p. (0.94%) less than its index.1Over all, the inter-
national equity portfolios, namely the U.S. Equity, Foreign Equity, Emerging Markets Equity and Québec International portfolios, returned 14.4%, or 41 b.p. (0.41%) more than the index.2The 21.0% return on the Canadian Equity
portfolio underperformed its index by 313 b.p. (3.13%), however.
1This index is the weighted resultant of the equity portfolio indexes.
2This index is the weighted resultant of the international equity portfolio
Figure 33 shows the sector breakdown of the investments and the weighting of the sectors in the Equity Markets group’s index as well as the contribution3to active risk by
sector.4The main active risks assumed are related to the
energy and financials sectors. In both cases, the share of risk is related to security selection rather than sector selection. The active risk assumed by the managers can also be sub- divided on a geographical basis. Figure 34 illustrates the breakdown of investments4and the contribution to overall
active risk assumed by the managers of the group’s special- ized portfolios. The contribution to active risk by geograph- ical markets comes essentially from security selection in Canada and the relative importance of investments in the United States.
3Adjusted contribution.
4Excluding the specialized Québec International portfolio, which is a structured
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Depositors’ net assets by specialized Equity Markets portfolio
figure 32
(as at December 31, 2005)
Québec International Foreign Equity
U.S. Equity
Emerging Markets Equity Canadian Equity $17.5 billion $10.9 billion $8.3 billion $6.9 billion $1.3 billion
Investment operations
Ener g y M at erials Industrials Consumer discr etionar y C onsumer st aples Health c ar e Financials Inf ormation technolog y Utilities 30 25 20 15 10 5 0
Investment breakdown by sector
Sector weighting in index Total active risk contribution
17.218.6 32 4 11 4 3 21 8 11.4 8.3 8.0 10.1 6.4 5.6 5.6 5.2 28.2 28.2 8.6 5.4 5.1 2.0 2.7 (in percentage – as at December 31, 2005)
Active risk breakdown by sector
figure 33 Telec ommunic ation ser vic es 13 10.9 8.1 7.5 4 0 C anada Unit ed S tat es Ru ssia Fr anc e Unit ed Kingdom Other countries 60 50 40 30 20 10 0
-10 Investment breakdown by country
Country weighting in index Total active risk contribution
N.B.: The negative contribution to active risk comes from a geographical diversification effect.
49.252.1 59 33 4 3 23.9 20.5 0.4 0.2 2.5 5.8 5.5 18.2 Active risk breakdown by country
figure 34
(in percentage – as at December 31, 2005)
19.6
2.1 3
Specialized Canadian Equity portfolio
In 2005, the Canadian Equity portfolio returned 21.0%, or 313 b.p. (3.13%) less than the 24.1% return on its index. Over five years, the portfolio’s return underperformed its index by 12 b.p. (0.12%).
Return on Canadian Equity
table 35
(for periods ended December 31, 2005)
Return1 Index2 Spread Information
% % b.p. ratio
1 year 21.0 24.1 (313) n.a. 3 years 21.2 21.7 (46) (0.4) 5 years 6.5 6.6 (12) (0.1)
1Excluding private equity investments.
2S&P/TSX Capped since January 1, 2003, S&P/TSX since May 1, 2002,
TSE 300 before.
The return fell short of the S&P/TSX Capped Index in 2005, mainly because of the defensive position taken in the energy sector. The managers adopted this stance in 2004 on the basis of an analysis of standardized historical prices. They accentuated this position at the end of 2004, when the price of oil reached a then-historic peak of US$43.45 a barrel. The energy sector was therefore slightly under- weighted in the portfolio, and the emphasis was on foreign integrated oil companies,5which are historically less volatile.
These securities, such as Exxon Mobil and Royal Dutch Shell, offered more attractive valuations at that point than did Canadian securities.
But the energy sector recorded a spectacular run-up in 2005. Canadian stocks in particular reached new peaks amid enthusiasm for unconventional energy reserves, such as oil sands and low-permeability gas deposits.
Absolute return operations, however, significantly enhanced the return on the specialized portfolio. Careful stock pick-
The information ratio for the managers of the portfolio is -0.1 over five years and -0.4 over three years.
Specialized U.S. Equity portfolios
The hedged U.S. Equity portfolio returned 5.3% in 2005, or 119 b.p. (1.19%) more than the 4.1% return on the index. Over five years, the return on the hedged portfolio is comparable to that of the index.
Return on U.S. Equity (hedged)
table 36
(for periods ended December 31, 2005)
Return1 Index2 Spread Information
% % b.p. ratio
1 year 5.3 4.1 119 n.a. 3 years 14.1 14.9 (83) (1.0) 5 years 0.7 0.7 (1) 0.0
1Excluding private equity investments. 2S&P 500 hedged.
The return on the unhedged U.S. Equity portfolio was 3.4%. The difference between the return on this portfolio and the hedged portfolio is due to the strength of the Canadian dollar.
The restructuring carried out in 2004 afforded the oppor- tunity to apply new processes for selecting external managers and optimizing the allocation of capital, which the portfolio benefited from.
External management generated a positive return as a result of effective security selection, especially in the health care, information technology, energy and consumer discretionary sectors. As for internal management, careful stock picking in the consumer staples and consumer discretionary sectors added value to the portfolio. Security selection in the energy, information technology, health care, telecommunications
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Investment operations
Specialized Foreign Equity portfolios
The hedged specialized Foreign Equity portfolio returned 28.1% in 2005, or 28 b.p. (0.28%) less than the return on the index.
Return on Foreign Equity (hedged)
table 37
(for periods ended December 31, 2005)
Return1 Index2 Spread Information
% % b.p. ratio
1 year 28.1 28.4 (28) n.a. 3 years 19.4 20.7 (134) (1.8) 5 years 0.0 1.4 (140) (1.2)
1Excluding private equity investments.
2MSCI EAFE hedged. The provisional index was used from October 2001
to May 2002.
The unhedged Foreign Equity portfolio returned 10.4%. The difference in the return on this portfolio and the hedged portfolio is due to the strength of the Canadian dollar. The changes made to the portfolio began to pay off in 2005, and the benefits of these changes should continue in 2006. Internal management experienced difficulties on the U.K. market, mainly because of security selection in the consumer discretionary, energy, health care and industrials sectors. Overweighting the telecommunications sector also sub- tracted value.
As for Continental Europe, overweighting telecommunica- tions and underweighting industrials subtracted value. Security selection in the financials, telecommunications and utilities sectors added value, however.
During the year, the Equity Markets group renewed its team of specialized external foreign equity managers, and the new management mandates yielded positive results, espe- cially in the information technology, consumer discretionary and financials sectors.
Specialized Emerging Markets Equity portfolio
The Emerging Markets Equity portfolio returned 30.5% in 2005, or 16 b.p. (0.16%) less than its benchmark index. Over five years, the portfolio has outperformed its index by 44 b.p. (0.44%), however.
Return on Emerging Markets Equity
table 38
(for periods ended December 31, 2005)
Return1 Index2 Spread Information
% % b.p. ratio
1 year 30.5 30.6 (16) n.a. 3 years 24.2 24.7 (51) (0.3) 5 years 13.7 13.3 44 0.2
1Excluding private equity investments. 2MSCI EM unhedged since July 1, 2000.
Selection of countries and sectors enabled the internal man- agement team to outperform the index. The results for exter- nal management were rather disappointing, however. The costs associated with cancellation of management mandates and redeployment of investment operations to new external managers also subtracted value.
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Specialized Québec International portfolio
The Québec International portfolio returned 19.4%, for 27 b.p. (0.27%) of value added in relation to its index. Over five years, the portfolio has outperformed its index by 11 b.p. (0.11%).
Return on Québec International
table 39
(for periods ended December 31, 2005)
Return Index1 Spread Information
% % b.p. ratio
1 year 19.4 19.1 27 n.a. 3 years 22.1 22.1 3 0.1 5 years 5.2 5.1 11 0.2
1Index based 20% on Canadian treasury bills and 80% on the SC Provincial
Québec Subindex plus a basket of equity futures contracts.
The portfolio’s value added in 2005 is due essentially to active management strategies for money market and bond holdings, as well as strategies deployed on the equity markets, especially the U.S. market . The Québec International Index generated 410 b.p. (4.10%) more than the hedged MSCI World Index, which returned 15%. Since inception, the Québec International Index has outperformed the hedged MSCI World Index, mainly because of strong results for Québec bonds, which represent 80% of the underlying assets.