Emerging market funds lead July bounce

Investors beaten up by market volatility in May and June were given a chance to catch their breath in July, as most mutual fund categories posted gains, according to preliminary data compiled by Morningstar Canada. Of the 31 fund indices Morningstar tracks, 28 ended the month higher.

Emerging markets funds were the top performers, with the Morningstar index for this category gaining 3.6%. These funds bore the brunt of the sell-off in May. Healthcare funds posted the second-best returns, gaining 2.9%.

Also rallying from the earlier correction were funds invested in the resource sector. Higher than average temperatures drove up demand and prices for energy commodities as North Americans cranked up their air conditioners. The natural resources fund index gained 2.9%, while the large-energy component boosted the income trust fund index by 2.6%.

Energy commodities were not alone in their recovery, as tensions escalated in the Middle East, driving up precious metal prices. Funds focused on this sector gained 2.5% in July.

“As has been the main story for the past several years, resources and financials were the key drivers of the Canadian equity markets in July,” says Morningstar Canada senior analyst Brian O’Neill.

On top of the rally in commodity prices, O’Neill points to “feverish” merger and acquisition activity as driving up share values in the resource sector. Some of Canada’s biggest names in mining were involved in massive takeover battles, including Inco, Teck Cominco and Falconbridge.

With deal-making in full swing and funds posting healthy gains, the financial services fund index climbed 2.3%.

Core holding funds posted solid gains after consecutive losses in May and June. The Canadian equity fund index earned 1.6%, while the Canadian equity (pure) fund index gained 1.8%.

Income funds were also on the rebound, with the Canadian Bond, Canadian Dividend and Canadian Income Balanced fund indices posting gains of 2%, 1.9% and 1.9% respectively.

Foreign investment gains were not limited to the emerging markets segment, as the European equity fund index gained 2.4%, while the Asia ex-Japan equity fund index returned 2.3%. These gains helped power the broader international equity fund index to a gain of 2% for the month.

“International equity funds have outperformed Canadian equity funds so far in 2006,” O’Neill says. “This is largely due to the strength of the European markets, with the European Equity fund index up 12% year to date. Along with solid individual market returns from France, Germany and the UK, a 4% rise in the euro and a 5% rise in the pound versus the loonie have given these funds a huge boost.”

Of course, there had to be some dark clouds over fundland in July. The U.S. Small & Mid-Cap equity index posted the greatest loss, tumbling 3.6%, followed by another U.S.-centric index, science and technology, which fell 2.8%.

“The U.S. Small & Mid-Cap Equity funds have struggled amid substantial, recent global volatility,” O’Neill says. “In July, these funds were hurt by the resource resurgence since most of them have only moderate exposure to the energy and materials sectors. Also, many have more than 20% exposure to technology, which has continued to flounder.”

The large-cap tech stocks that make up the core holdings of many tech funds provided little shelter, as share prices were generally weak among eBay, Yahoo, Dell, Google and Nortel, O’Neill points out.

Bucking the U.S. trend, the Canadian small-cap equity category managed to gain 1%, which is likely attributable to the sheer number of small caps involved in energy exploration and development.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(08/02/06)

Steven Lamb