Hello and welcome back to the Institutional Beat Podcast, where we cover interesting and relevant topics for institutional investors. I'm your host, Slava Sherbatov. And today we're going to talk about active management of equities in the current market environment. It is no secret that the last few years have been challenging for fundamental active managers to deliver outperformance, especially in large-cap U.S. and global equity markets. And we're pleased to have who we think is the perfect guest to help us understand this environment and how to manage through it: Stu Kedwell, global head of equities at RBC Global Asset Management.

Stu, welcome to the podcast.

Hi, Slava. How are you doing?

Pretty good, pretty good. And how are you doing?

Great. Thanks for having me today.

No, it's a pleasure. We know you're a popular guest on another podcast that we host as a firm, so we’re glad you were able to squeeze us into your busy schedule.

Well, before we start, Stu, I'm just going to take a minute and introduce you. As many of our listeners know you, I know you've met many of our clients over the years, but some may not. And so, just a couple words about Stu.

He is one of our most experienced investment leaders, having spent his entire 30-year career with our firm, in progressively senior roles from investment analyst to portfolio manager to co-head for North American equities. In fact, Stu was instrumental in building out our North American equity team alongside his longtime partner, Doug Raymond, and most recently taking on the role of global head of equities, overseeing all of our equity teams. Stu also sits on our firm's Leadership Committee as well as Investment Strategy Committee, which sets the tactical asset mix across our multi-asset portfolios. In addition to all of this, and Stu, hopefully you agree with this, but I think you are known as one of the more interesting people to talk to about markets, and not just because of your knowledge and insights, but also because of various quotes and analogies that you use to bring concepts to life.

So, no pressure, but hopefully we can get a couple of those out of you today as well.

Yeah, for sure.

Alright, so before we get to the main question, can you just take a minute and talk about the equity franchise that you oversee and your role as the global head of equities at the firm?

Yeah, for sure. Well, we're very fortunate here because we have equity management across every region and every style of money management. And you mentioned that I’ve taken on our global teams this year. Before that, all the North American teams were under our purview. And we really thought that that benefitted us by having growth, value, dividend, core, long-short across U.S. and Canadian markets, having that all in the same team. We're big fans of scenario analysis, and you could have these very fulsome debates around a topic because you have two different teams approaching the same stock from a different mentality.

And this year we've expanded that. So now we have our Asian equity team which is based in Hong Kong. We have our global, our EM, and our European equity teams based in London. And our small- and mid-cap equity team based in Chicago. And of course, our North American team includes what we do in Vancouver and what we do in Toronto.

And I think it's just been a huge benefit – diversity of opinion, diversity of thought – which is a crucial component to the investment business. We've really benefitted from that. And then, the other thing, as a team, we sit down and we spend a lot of time talking about investment process. Investment processes is what gets the job done through many years and many different cycles.

So, we've all presented our investment processes to each other. I think in one form or another, there's three components: there's identifying good businesses, identifying which ones we want to own, and portfolio construction. Any investment team has some focus on those three things.

You mentioned my partner, Doug Raymond, who used to say: “Which horses go in the barn? Which horses come on the track? And how do you kind of suit them up (meaning – which weight do you put them in and what have you)?” So we're looking at portfolios in those three dimensions everywhere in the world. Each team has a portfolio engineer. We've changed that – I wouldn't say necessarily changed – but we've augmented some of the focus of those teams through the year. And we're very fortunate to have this massive resource.

Yeah. Thanks, Stu. And I think a lot of the things you just described also puts you in a pretty good position to speak to this next question. I pointed out in the beginning that it has been a tough period for active management. And admittedly, we certainly have not been entirely immune from this in some parts of our business, but it has been a general theme in our industry. For example, depending on the source that you look at, it's not uncommon to see major large-cap indices, whether it's S&P 500, MSCI World, or even whole-market, rank pretty close to the top quartile in terms of performance. Dating back not just this year, but three and five years. And for reference, we're recording this in October of 2025.

So, can you talk about what's been driving this and why it's been so difficult to outperform in some of these markets?

When markets are – what I call – markets are concentrating, right? So the larger stocks, the larger index weights, are getting larger. That's a challenge for active management. If you don't have a full exposure to those companies. Traditionally, active managers had this benefit that – if my portfolio beat the average stock in the index, I outperformed. That was always one of the keys to EM. It was one of the keys to global. For a lot of years, it was the key to the U.S. And that has changed. It started in the United States, but that has changed quite dramatically because of the concentration at the top of the stock markets.

Now it's interesting, as a Canadian investor, this goes back to the diversity of the franchises. A lot of Canadian money managers went through this with Nortel, where a stock climbed to 38% or 36% of the index, or whatever it reached at its zenith. And owning it – or not owning it – was the deciding factor of portfolio management. There were managers that owned it and they were smart on the way up…and then they still owned it when it went down. And all of a sudden, they weren't viewed quite the same – and vice versa – people that didn't own it on the way up then became kind of brilliant on the way down. And this one stock really defined your longer-term track record. Canadian markets have always been a function – because they're quite concentrated – they've always been a bit of a function of what you own and what you don't own really defines your performance. Canadians, I think, we're kind of used to this. So when the U.S. market started to concentrate, we focused a lot on portfolio construction. And unfortunately, other markets around the world – even like small-cap land – which, again, beating the average stock used to always define a good performance in the small-cap land. This year, the average stock in the small-cap index is hundreds of basis points behind the small-cap index. That's just very rare, even in that universe where you're capping the size of the largest companies. But even in those ones, the largest companies have dominated performance.

We do often talk about outperforming any given benchmark is never easy – even under normal circumstances. If there is such a thing. I don't know. And you just flagged the few things that that might get in the way, or managers have to contend with today. So what can you do about it? And without giving away any secrets, what are some of the things that you think are important for managers to focus on to kind of help navigate through this market environment?

Yeah. Well, there's a couple of things, I think. The first is, for a long time when you when you made the decision to kind of own the index, what you were signing up for – particularly in the S&P 500 – was getting exposure to this long pattern of around 7% earnings growth from the S&P 500. And so, if you bought the index, you kind of collected the earnings growth and a little bit of a dividend to get not an unreasonable equity market return. And sometimes active managers beat it and sometimes they didn't. But there was much greater outperformance during that period of time. But some people just said, “Well, I'm a long-term investor, so what's most important to me is that 7% earnings growth.” Today, the S&P is still growing its earnings, but the earnings growth has been heavily dominated by a handful of companies – and those companies are now very large inside of the index. So, choosing passive – whether that's the S&P or globally – it has become a more active decision than it may have been in the past because you are very exposed to the earnings that have been created by a handful of companies.

And these companies have very strong financial characteristics. But the history of the top companies remaining at the top for long periods of time is not great. Like, you can go back through time, and every decade, the top companies rarely are the new top companies, kind of ten years later. Before we get into some of the challenges – like, even if you buy the TSX as a passive investor, you really need to make three decisions around gold, energy, and financial stocks – because those are three large components that are going to have some impact on how the headline index does. Historically, on the S&P, you didn't really have to worry about that because it was very differentiated. Now, again, it's quite exposed to what we know as the Magnificent Seven. And as a consequence of its growth, the global index looks not dissimilar because the U.S. has gone from around 50% of global stock markets to around 70%.

If you look in the last in the last ten years, U.S. stock markets have almost doubled relative to the rest of the world. And you've seen this big hike in their weight. And so, even within the global index, you have some of these same concentration implications that you have in the S&P. As far as concentration implications are concerned – like, we can look at the TSX where, the Royal Bank is not a dissimilar weight in the TSX and NVIDIA is in the S&P 500.

It's really what we then have to go into on these indexes that have concentration – the scenario analysis and the range of outcomes for each business under that weight. Right? And so, you can take you can take a business like the Royal Bank and say, “Boy, over a long period of time, the return on equity might be X. At the peak, it might be like X maybe -300 basis points during the trough.” But it's a narrower range of outcomes. So, you don't feel quite as vulnerable as a long-term investor in holding that percentage of your capital in that stock. When it comes to some of the larger businesses in the S&P 500, the margin profiles of these businesses are nothing short of stunning. And the persistence of those margin profiles is probably the major concern or question mark around those businesses. The revenue growth has been spectacular. But Microsoft, all of these companies, have witnessed this not only very strong revenue growth, but spectacular margin expansion at the same time.

So, when we go forward and we look at the scenarios, you might have earning or revenue growth that doubles or triples nominal GDP – but will the margin profile hold? And you kind of have both revenue and the margin profile holding as a source of risk in some of the larger indices in the S&P 500, relative to what you may have had historically. For active managers, you're doing scenario analysis all the time. So, the three ways that traditionally you would make money in a stock are: the revenue would grow, the margins would expand, and the valuation might expand. And sometimes you get all three. That's where I say like, when you get into those top companies where the S&P is trading at 22 or 23 times earnings – which is elevated relative history – justifiable if the margins stay here, because with wide margins, you get a lot of free cash conversion, which attracts a higher multiple.

But, within that 22 or 23, it’s kind of the tale of two markets – which is seven or eight businesses that trade at meaningful premiums, and the average stock still trading in a mid-to high teens multiple situation. So, as active managers, you have to kind of think through: do I want to own these businesses?

And then, if I decide I want to own them, you have to think about the portfolio construction, and whether or not you're running a core mandate, or a mandate with a very specific overlay, like value or dividend or growth. That's going to have implications for how you construct your portfolio as well.

Got it. And so, you talked a little bit about the different philosophies and different processes that our teams follow. And we spent a lot of time talking to clients about this as well. And the fact that, generally speaking, philosophy and process – they don’t change over time – they're pretty consistent. But what can and does change are the different tools that managers can use to execute successfully on that process.

And you talked a little bit about scenario analysis potentially is one of the things that can help. Are there any other tools or ideas that you're thinking about there may be helpful in this context?

Well, the three primary – as a portfolio manager, you're always looking for things that trigger you to ask questions about your portfolio, right? The stocks I own – should I continue to own them? Or should I continue to own them at the weight that I own them?

So, what causes that trigger? Your scenario analysis. If the stock starts to really approach your bull case, and you have a bunch of other companies you like that are still factoring in the base case, that's an obvious reason to switch. Quantitatively, we have a big quantitative practice here. I didn't probably didn't give it its credit, even in the opening salvo when I was focused more on some of the fundamental teams. We have a great quantitative practice here. We have a quantitative model that takes stocks in a market and ranks them by deciles. And when you look over time, the first decile outperforms a second decile outperforms a third decile, and so forth.

So you can give the portfolio manager – even the fundamental portfolio manager – and say, “Here, you have some companies in lower deciles. Should we re-underwrite or rethink our fundamental thesis because this model is suggesting that, maybe something is challenged?” We're not big – we don't use technical analysis to buy and sell stocks.

You mentioned the quotes on my wall. One of them is from Barton Biggs, which was: “When I go hunting, I take my dog – but I don't give him the gun.” And technical analysis, in our minds, is that. It is a reflection of the conversation that's taking place in the marketplace. When stocks are bottoming and momentum is going from negative to positive, we want to have a system that forces the fundamental analyst to envision: what might the stock market be sniffing out? And the same thing – if a business starts to top – where it's saying, well, this company is starting to lose momentum – should we go back and think, fundamentally, is everything actually as good as we thought?

And then, you can look at things like estimate revision and revenue revision, and forward indicators on both of those. So, we have all these mechanisms that you kind of you take back to the portfolio manager and they’re just a way of questioning.

I've got a bazillion things on my wall, but one of them is: “It's not being wrong that kills you, it's staying wrong that kills you.”

So these questions go back to the portfolio manager, and just a way of saying, “Are we sure about this?” And that's awfully important when it comes to the different tools that are in place.

So, it's not just like, “Oh, I'm going to own these 30 stocks for the rest of my life.” It's, “I own these 30 stocks, which I like” – or whatever the number of stocks is – and then I constantly question their role in the portfolio.

You also give a couple of examples earlier – one was with Nortel and the other one was how leadership can change over time in the stock market. We actually reference to those very same things in our seminar earlier this year that we hosted for clients all across the country.

And so you talked a bit about some of the challenges, some of the tools, or how investors can approach this. And I know you're a student of history and the markets. This is clearly not the first time this is happening – and probably not the last time. Can you talk a little bit about, in general, how could these things play out potentially over time?

So, when you are thinking about different scenarios, what are some of the scenarios that you're contemplating based on how things might have played out in the past? Doesn't mean it's going to repeat itself here today, but just to give people some context about how to think about it.

Yeah. So, like right now there's been a lot of strength out of the financial sector, of the industrial sector, in the technology sector. And so, from a financial standpoint, stress testing a financial company is a little bit more straightforward because you can go look at their loan book and you can make some assumptions around the potential for provisions for credit. You can look at reserves and say, could this company need more reserves?

In Canada, our banks have been putting up a fair amount of reserves, actually, so feel okay about that. So you have that component. Then the industrials and the technology sector have been heavily focused on data centers and the build out for artificial intelligence.

So, there's a couple of things that you can look at. When you look at a lot of these big technology companies, you quickly look at the margin profile. It's not whether or not revenues are going to keep growing. It's really the margin profile in our minds.

We have a group here, that we're studying the effectiveness of data center economics a lot. Right? When you when you take a data center, you're taking power, you're constructing the facility, you need some coolant, HVAC, then you need a bunch of servers, and those servers produce a bunch of tokens or a bunch of units that you can sell to users of artificial intelligence – whether or not it's for training or for inference. And the economics of that facility will be highly dependent on the price that you produce the tokens for and the demand for them. And the thing that's interesting there is, the speed with which new servers, are becoming more efficient. And does that affect the economics at all of in-place capacity? So these would be a way – spending a lot of time on data center economics. You may or may not own a specific data center company, but this is going to be quite important to the revenue growth and the margin profile of some of those larger businesses.

We're spending a lot of time on that to try and come up with scenarios about how those businesses could progress into the future. So, any time you're making an investment – whether or not the market as a whole or a company – you say, well, what is the bull case? What is the bear case? Debate. And where does the stock sit relative to that?

We've been in an environment where good news kind of keeps getting put into these stocks a little bit more. There's a lot of positive momentum. There's single-day options. You know we mentioned passive. There's the triple Q (Invesco QQQ ETF that tracks Nasda-100 index) , which augments the amount of money that flows to some of these names and portfolios.

But once something gets to maybe more advanced than even your bull case, then you want to be very wary, should one of the indicators we talked about before start to flash red – quantitatively, the business starts to change, or technically, the business starts to change – because from your scenario work, it's quite elevated maybe relative to your base case assumption.

Thanks. I think one thing that's clear is while you are Global Head of Equities, I think you're an investment analyst at heart. That's probably would never change. And I think it's great having seeing you communicate and engage with different members of the team it comes through all the time as well.

Now, you did touch on passive a couple of times. We talked about this as well before we started recording. And you kind of talked a little bit about what passive investments used to represent versus what you perhaps are buying today. Can you just – and I know you may be repeating yourself a little bit – but could you just revisit that? Because some of those comments were quite insightful.

If you look at the if you look at a graph of the long-term earnings growth of the S&P 500, it's around 7%. And that's been through, all sorts of environments. Sometimes it dips below and then it rebounds back to trend. But even if you were at the peak of the financial crisis, the S&P earnings forecast for 2008, I think, was $100 when we started in 2008. And earnings ended up bottoming around 60, largely because of a lot of write-offs in the financial sector. But if you bought the S&P at 15 or 1600 and you're paying 16 times earnings on the eve of the financial crisis, ten years later, the earnings of the S&P were around 200 – like they grew around 7%. And the fact that Bank of America and Citigroup were big companies, but they weren't big weights in the index – the fact that they fell away and new companies picked up the ball and ran with it o the earnings front, it didn't really affect your success as a passive investor. Today, you sit there with a lot of exposure to 7 or 8 names and those 7 or 8 names do have linkages. They're not all dependent on each other, but some of them – there is some codependence around the success of artificial intelligence and what have you. So, it might be a little bit more challenging for the market today if those 40% are not compounding at that rate. If they stumbled, it's harder for the other 60% to pick up the ball and run with it quite the way that it might have happened in the past.

And this is probably where active approach may actually pay off, even though it's been more difficult to deliver in the last little while.

Well, yeah. The role passive has received a lot of flows because of some of the thesis that we just discussed. I do think it's changing a little bit. It's just the range of outcomes or what it depends on is different than it might have been at the initial onset.

Right. And so, what we look through – and we look through all of our active funds – and I know we're going to talk about this, or just kind of segue to it – we look through all our active funds and we look at performance in four buckets.

We look at the alpha that comes from the stocks we own. We look at the negative alpha that comes from the stocks we own. We look at the positive alpha that comes from the stocks we don't own. And we look at the negative alpha from the stocks that we don't own. And you can look through performance, but right now that fourth bucket is impacting a lot of investors – which is the active way of saying, I don't have quite the same exposure to a bunch of stocks that the index does.

And so far, that decision hasn't necessarily proved fruitful. But over the fullness of time, maybe it's worth adding into a variety of exposures. When we look across our performance across our firm, the first bucket is quite healthy, which is what you would want from an active manager. The second bucket, in certain instances, we've tightened up some of our – what we call – this kind of “tsunami warning” that we talked about at the beginning, the usage of quantitative analysis and things like this. Like putting a warning system in front of people that says, “It's flashing on the stock. Should we go and rethink it?” I think that no matter what, that's going to be an important bucket. Then bucket three used to be very large for active managers because, say, when the market wasn't as concentrated, you might have – I don't know what it is – 20, 30, 40% of the market underperforming by 8 to 10%, or something like that. That used to generate you, say, 400 basis points of performance. Today, that bucket (bucket three) has maybe shrunk in half. It's only generating you half the performance that it once did. And bucket four is very large because it's growing as the market concentrates. Bucket four has gotten even bigger. Will there be a day that bucket four moves back to bucket three? You know, that's kind of like the dream of the active manager to some degree.

But in the grand scheme of a portfolio, I think if you're looking at managers and bucket one is pretty healthy. At the end of the day, we buy equities to compound our money at earnings growth plus. And that equation of bucket one is: revenue growth, margin expansion, valuation expansion. You know, these are tried and tested tools – whether or not you're in private equity, whether or not you're in public equity. That's what you're really looking to fill your portfolio with because those are the businesses that come with these positive options. And when they present themselves, we're not entirely sure, but that's what really drives good long-term risk-adjusted returns. If you find someone who's been hamstrung by bucket four, you're probably willing to be more patient with them in the grand scheme of things.

Yeah, and bucket four – just to remind everyone again – it's the negative alpha of firm securities not owned in the portfolio.

As an example – like, if you haven't had enough NVIDIA.

Right.

Then that's – like – bucket four could be quite large if you haven't had exposure to a handful of stocks.

Yeah. So, you've given us a couple of quotes and references, so thank you for that. The one saying that you use from time to time that really resonates with me is that “every storm eventually runs out of rain.”

Yeah. And I think it's a stretch to categorize the environment for active as a storm. But there are definitely some clouds. And I think it's probably fair to say – but is there a silver lining? And I think there are some things you've already kind of touched on in terms of why investors should feel comfortable, assuming there is good consideration for some of the things that you talked about throughout the podcast. But are there other things that you may be able to point to – give you a little bit of comfort in terms of silver lining in the outlook for active management in the in the next little while?

Well, I think when you think about the long-term kind of aspect of active management – it used to be, on the way up, I'll try and keep pace. And on the way down, active managers are normally pretty good at risk management, right? The kind of the same thing that's maybe kept them out of having a full weight in some of the very spectacular stocks. That's basically a comment saying, “I'm unwilling to take that risk that the market's willing to take.”

Right? If you took a company like Palantir – whatever times sales it is. As fantastic as the revenue growth is, by saying “I'm not owning Palantir,” you might be saying, “I don't like the business,” or you might just be saying, “I'm unwilling to accept the price of that business.” The stock market is a big scale – you have the valuation and the business. And if one gets too far advanced, then you're just pulling forward too much of the future into today's valuation. In a decline, an active manager should be able to identify some of those risks.

And everyone says, “Well, what's the point of owning an active manager when markets go down? Why wouldn't I just not own the market?” Which is valid. But at the same time, when we're long term investing, how you put your track record together over a long period of time is a combination of keeping track. You either keep track and outperform on the way up, and then don't go down as much when the market goes down – or it’s some combination of those two things.

I think you could probably make the argument that the longer we get into the bull market, the active manager might be a spot that kind of protects capital, should we go sideways. The interesting thing is, it's not even like the top stocks need to go down. They just need to really start to go sideways. In the tech bubble, the large companies went down – although they didn't have very much representation in the S&P. The U.S. Federal Reserve (Fed) started cutting interest rates, and the rest of the economy took off. Right? So, in this instance, maybe we could have those stocks digest their gains and other companies start to do better – as maybe we get some monetary stimulus or something like that.

So, there's lots of ways to bake the cake. I think over time, as I say, as investors, we want to attach ourselves to earnings growth, dividends, margin expansion, hopefully valuation expansion. Some of those ingredients look more fully priced in some of those big names.

Thank you, Stu.

And maybe that's a good place to wrap it up. You gave us lots of things to think about, and I really appreciate your insights and transparency in how we approach these markets – and what we're doing even within our own team. So thank you very much for joining us. Thank you for your time.

And I also want to thank our listeners. I hope you enjoyed this podcast and will join us next time. Thank you.

Thanks, Slava.

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