Equity funds lead January retreat

Last year may have been the best 12 months that mutual fund investors have seen in the last 15 years, but 2010 is off to a poor start, according to data compiled by Morningstar Canada.

In the first month of the year, 30 out of 43 Morningstar Canada Fund Indices posted negative returns, as stock markets turned sour. All but three of the 24 funds that track equity mandates sank into the red.

As is so often the case, what has gone up has come back down. The once high-flying Precious Metals Equity Fund Index has posted an 8.1% decline in January, making it the worst performing category year-to-date.

The first week or two of 2010 seems cheery enough, but then two of the world’s most influential economies threw policy wrenches into the works.

“The People’s Bank of China raised the reserve requirement for depository financial institutions to rein in liquidity, and interest rates increased slightly in what may be the beginning of a larger trend to start taming inflation,” says Esko Mickels, fund analyst for Morningstar Canada.

Not to be outdone, U.S. President Barack Obama laid out a plan to overhaul the American financial industry, which would restrict banks from participating in lucrative, yet risky, fields such as hedge funds, private equity funds, or proprietary trading.

“This weighed on U.S. banks as well as Canadian banks with U.S. operations,” Mickels says. “As a result, equity markets witnessed a partial unwinding of the risk trade in the second half of January, and last year’s top-performing fund categories, which are also among the riskiest, suffered.”

Following the precious metals index, the greatest declines came in the Greater China Equity (-7.1%), Canadian Equity (-5.4%), Asia Pacific ex-Japan Equity (-4.9%) and Emerging Markets Equity (-4.8%).

“Concern about China’s monetary policy moves dented commodity prices, which hurt both Asian and Canadian equities.”

Of the few equity categories that rose, some of the gain came on the back of the declining loonie. The Japanese Equity Fund Index gained 3.8% for Canadian investors, despite a 3.3% decline on the Nikkei stock market index.

“The gain was made possible by a 4.8% rebound in the yen versus the Canadian dollar, after it had fallen by 8.5% in December,” Mickels said. The falling loonie also limited losses in many foreign equity fund indexes.

The only other equity indexes that posted positive returns were Health Care Equity and Real Estate Equity, which returned 1.3% and 0.8%, respectively. Both sectors are traditionally seen as defensive plays.

Fixed income lived up to its role in diversification, providing an island of stability amid the stormy seas of the equity markets. The Canadian Long Term Fixed Income Fund Index posted a 2.6% gain, making it the second best performer among the 43 indexes. The Canadian Fixed Income Index and High Yield Fixed Income Index each gained 1.8%.

(02/02/10)