This article was first published in the Globe and Mail on May 4, 2024. It is being republished with permission.

by Tom Bradley

The quarterly reporting period is just winding up. It's the time when investment managers tell us what's happened in the market, how the funds did, and provide some insights into their strategies.

Our company uses outside fund managers, so my inbox was full of reports from companies that work with us – or hope to. The good news is that everyone has access to this information online (with a few exceptions).

Below are some themes from the first quarter, along with tips on how to read the reports.

Context

Most managers start with a review of how markets did and what was particularly strong or weak. In the first quarter, equity markets were up, led by dramatic moves in commodity producers and a few mega-tech stocks. Bonds had a small negative return because of an increase in interest rates.

Market overviews provide context for looking at your own portfolio, but keep in mind, a quarter is a short, arbitrary period that will have a tiny effect on your long-term return. And they're all the same, so read one and skip the rest.

How did I do?

Next comes fund performance. The commentary here is also short term in nature and may be accompanied by detailed attribution showing which stocks and sectors contributed and detracted from returns. It's overkill to analyze such a short period, so I suggest looking for any detailed reviews of stocks that have broken out or broken down. This provides a better window into the manager's thinking.

Fortunately, every report includes a table showing long-term returns. This deserves more of your attention. In recent years, the dominance of the Magnificent Seven stocks has made it difficult for active managers to beat the indexes. For reasons of diversification and risk control, it's been almost impossible to own enough of these stocks.

Periods of poor performance like this are painful but useful. They reveal just how committed a fund manager is to their philosophy and process. I learn the most about a manager when they're getting pressure from clients and are on their heels.

For instance, my antenna goes up if they start buying stocks that don't fit their philosophy. I learned this in the late 1990s when some underperforming value managers bought high-flying Nortel and JDS Uniphase. It was their death knell.

What's economics got to do with it?

Economics is a staple in quarterly reports. Clients like to read about economics, so managers dutifully provide charts and commentaries, even if GDP and inflation forecasts don't factor into their investment decisions.

This quarter, most managers highlighted the increasing likelihood of a soft landing. One manager put a 50-per-cent probability on it, which reflects the current consensus. Inflation was also a common topic. Over the past year, it has trended down toward the central banks' target range, but the last per cent or two is proving to be sticky. Managers who are less optimistic about interest-rate cuts pointed to rising wages, which ripple through the economy, as a reason why the last mile will be challenging.

Regarding interest rates, some managers made the mistake of talking about when they come down, not if. This sends up red flags because, as I pointed out in a recent column, declines are far from a certainty. Does the manager need lower rates for their strategy to play out, or are they anchored on the abnormally low rates of two years ago?

Price paid

Most equity managers acknowledged that valuations are getting stretched. Price-to-earnings multiples have increased in recent months. One British manager went so far as to say, “Markets look as stretched as they did back at the end of 2021.”

Fixed-income managers are saying much the same thing about corporate bonds. The reward for owning a riskier corporate bond as opposed to a government bond is as small as it ever gets. In other words, credit spreads are narrow by historical standards.

On a more optimistic note, several global managers pounded the table about opportunities in emerging markets. Smaller companies from Asia or South America always trade at a discount to large U.S. companies but the gap is wider than normal. EM has been an underperformer for a dozen years now. Managers of North American small-cap funds also pointed to a significant valuation gap.

A quarterly report has a short shelf life. But there are important nuggets to be found if you're mining for insights into the investment manager and their long-term approach.