Market downturn hammers July fund performance: Morningstar

The market downturn at the end of July turned a promising month of growth into a generally poor one for most mutual funds, according to preliminary fund performance data released today by Morningstar Canada.

Morningstar says that fund performance for most of its fund indexes appeared to be heading for another month of solid consistent gains. Since July 20, market volatility and a decline in most of the world’s major equity indexes have sent fund performance downward. As a result, most Morningstar Canada fund indexes suffered an overall decline on the month.

“Investors were spooked by a stream of bad news during that week, and that sent the markets on a white-knuckle ride,” says Morningstar Canada fund analyst Bhavna Hinduja. “A weakening U.S. housing market, spreading sub-prime mortgage problems, high crude oil prices and concerns over a slowdown in the world economy were the primary drivers of the negative sentiment that led to a sell-off in most equity markets.”

Canadian equities were certainly not immune. Morningstar highlights that in Canada, the S&P/TSX Composite Index dropped 5.9% from July 20 to July 27 to finish the month down 0.1%. Not surprisingly then, Morningstar estimates that those funds tied to that benchmark also took a nosedive. Morningstar’s Canadian Equity fund index was looking at a 4.5% month-to-date gain on the morning of July 20 but finished with a paltry gain of 0.4%. The Canadian Small/Mid Cap Equity fund index was similarly up 5.1% but closed the month at a loss of 0.2%.

Canada’s three major sectors — energy, financials and materials — lost 6.5%, 4.9% and 6.7% respectively during the week of market downturn. Morningstar says that the S&P/TSX energy and materials sub-indexes were able to recover while the financials sub-index ended up losing 2.9%.

This resulted in a moderate increase in Morningstar’s Natural Resources Equity category funds in the Natural Resources Equity category, most of which invest predominantly in Canada. Collectively, they gained 1.1% in July.

The Financial Services Equity fund index, though, finished third from the bottom, with a 3.7% loss.

“A lot of the financial sector’s decline had to do with risk aversion by investors who were nervous about the stream of bad news that followed this past week,” Hinduja says, adding that there was a lot of speculation over whether Canadian banks had significant U.S. sub-prime exposure, which additionally led to their sell-off.

Not surprisingly, these fears were even more amplified in the U.S., where the sub-prime problems are the most acute. The U.S. market was hit hard during July, and anything with a significant association to U.S. equity or real estate followed suit. The average Financial Services Equity fund had 29.4% exposure to the U.S. while the average Real Estate Equity fund had 17.5% of its assets in real estate. Morningstar says the Real Estate Equity fund index was the worst overall performer in July, with a 4.8% loss.

Another category with substantial U.S. exposure ironically was Canadian Anchored Equity funds. There’s been a huge push by the industry to talk up the diversification potential of these funds, which maintain 50% of their assets in Canadian equity and invest 49% in foreign equity. Christian Charest, Morningstar Canada’s associate editor, says that the foreign content of these funds tends to be top-heavy in U.S. equity. This fund category finished at a loss of 1.4%on the month.

Charest says some of the Canadian Anchored Equity funds carry as much as 45% exposure to U.S. equities.

“This category was a mixed bag,” he says. “In the Canadian Anchored Equity, the average U.S. component is about 16% on average. International is about 12%. Everything other than Asian exposure would have dragged it down.”

Those with Asian exposure fared well according to Morningstar’s estimates. For the second month in a row, the Asia Pacific ex-Japan Equity fund index was the best performer among all fund indexes in July, with a gain of 5.3%. Morningstar says the hot markets of China and South Korea were the main contributors to this performance.

Morningstar says China’s strength also lifted the Emerging Markets Equity and Asia Pacific Equity fund indexes, which finished the month in third and fourth place, with returns of 4.2% and 2.3% respectively.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com