Equity funds pummeled in Q1: Morningstar

Going global proved a treacherous journey in the first quarter of 2008, as foreign stock markets dragged down the returns of mutual funds that invest in foreign equities, according to Morningstar Canada.

Cushioning the drop in foreign markets, the Canadian dollar fell steeply against many of the world’s major currencies.

While the S&P 500 fell 9.4% in the first three months, the Morningstar U.S. Equity fund index declined by only 7.9%, thanks to the rising U.S. dollar.

Markets were thrown into a panic worldwide, as U.S. investment bank Bear Stearns teetered on the edge of oblivion, eventually being bought out by JPMorgan Chase – and even then only with the intervention of the Federal Reserve.

“Besides causing speculation that other firms would require similar bailouts, this action received mixed reviews,” said Philip Lee, fund analyst for Morningstar Canada. “Proponents of the plan argue that keeping Bear Stearns from going under would provide some stability to a troubled financial system. However, others have been critical of the Fed’s involvement because it essentially puts the public on the hook for the investment bank’s greed and mistakes.”

The ensuing sell-off shaved 7% from Morningstar’s Global Equity index and 8% from the International Equity index for the quarter.

“Also, continued waves of liquidity injected by many of the world’s central banks and the lowering of interest rates in the U.S. sent mixed messages,” Lee said. “Many investors took this as a sign that the U.S. financial system is in rougher shape than predicted. Naturally, this was bearish for equities around the world, particularly financials.”

A global flight to safety drove up the value of fixed income investments, driving a 6.8% first-quarter gain in the Global Fixed Income fund index. The soaring price of gold, also fuelled by investors seeking a safe haven, pushed the Precious Metals fund index into second place for the quarter, with a return of 4.3%. That return would have been even higher if not for the precipitous fall in value posted in March, when the category plummeted 7.7%.

Domestic fixed income categories were also among the top performers, but lagged foreign bond returns because they lacked the tailwind provided by the loonie. The Canadian Inflation-Protected Fixed Income index earned 4.2%, while the Short Term Fixed Income index rose 2.5% and the standard Canadian Fixed Income index gained 2.4%.

The worst returns for the quarter came in the Science & Technology Equity fund index, which fell 11.9%, followed by the Asia Pacific ex-Japan index, which fell 10.4%. Rounding out the bottom three, the U.S. Small/Mid Cap Equity index dropped 10.0% on the quarter.

For the month of March alone, the European Equity category was the top performer, returning 4.5%, just ahead of the tiny Real Estate Equity index, which turned in 4.2%.

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