Financials, foreign equity hit hard in Q2

Foreign equity was the wrong place to be in June, as mutual funds in that sector followed a disappointing first quarter with dismal returns for the second quarter, according to Morningstar Canada.

Losses for the second three months ranged from a high of 4.7% for the Asia Pacific Equity Fund index to a low of 1.8% for the Emerging Markets Equity Fund index.

Only two foreign-focused fund categories managed a positive return over the course of the second quarter, with U.S. Small/Mid Cap Equity earning 2.5% and Japanese Equity creeping higher by 0.3%.

Investors who hoped that the credit crisis had largely passed took the hardest hit, though, as the narrowly focused Financial Services Fund index plummeted 10% in June alone, for a quarterly loss of 7.7%. That makes it the worst performer among 42 Morningstar Canada fund indexes.

The Real Estate Equity Fund index wasn’t far behind in the losers’ derby, falling 6.5% for the quarter and 8.2% in June.

“The plight of financials worsened in June, particularly in the U.S., where the financials sub-index of the S&P 500 dropped almost 19% [in US$],” said Jordan Benincasa, fund analyst for Morningstar Canada. “Optimists had looked for a short and shallow period of firms purging bad loans, but it became a protracted credit crunch that crimped or eliminated profits of companies well beyond Wall Street banks.”

Not surprisingly, the Natural Resources Fund index was the big winner for the second quarter, turning in a return of 14.2%. It was followed by the Canadian Equity and Canadian Income Trust Equity fund indexes, which returned 9.1% and 8.3%, respectively.

“These stellar returns stem from global thirst for energy, metals and agricultural commodities,” Benincasa said. “Oil crossed the US$140-per-barrel threshold in late June, which helped drive up the prices of cheaper alternatives like coal and natural gas. Moreover, demand for industrial metals such as iron ore and copper has not abated.”

Inflation fears stoked demand for real-return fixed income securities, which contributed capital growth to funds in the Canadian Inflation-Protected Fixed Income category, which gained 3.5% for the quarter. As the price of these bonds rise, however, their yields have been compressed, making them less attractive as a parking spot for capital, Benincasa says.

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

(07/03/08)