First Quarter Fund Performance Review
A bruising first quarter left Asia funds licking their wounds. Here's our rundown of all the major trends.
Well, that certainly hurt. The just-ended first quarter of 2008 has left equity funds bruised and battered across the regional and market-cap spectrum. As the sub-prime crisis continued to claim victims--Bear Stearns the most notable--and the question became not whether the US was headed for recession, but for how long it would last, global equity markets took a sharp tumble. The MSCI World index dropped 8.9% in the period, and many segments fared worse. In that environment, lower-risk assets such as bonds and perceived safe havens such as gold attracted investor's attention.
Asia Funds Slide: China and India Funds Hit Hardest
Closely related to the above, the headline news in the quarter was the sharp down turn in Asian funds, particularly those focussed on India and China. Preliminary data show the average fund in the Morningstar India Equity category fell 25.8% in Sterling terms in the quarter, and the average China fund dropped 23.7%. The downturn is the logical counterpart of fears over the impact of a US recession on the region. It also is the consequence of valuations pricing in lofty growth rates that are now being perceived as potentially more difficult to deliver. China's growth is expected to be 9.4% in 2008, down from 11.4% in 2007, but still robust. In the case of India, economic growth has slowed from its breakneck pace of 9.6% in 2007 and recent data suggest a manufacturing slowdown. In both cases, the spectre of inflation has kept monetary policy relatively tight.
In the face of a difficult economic environment made worse by the appreciation of the yen versus the dollar (making Japanese goods more expensive for the American market to purchase), Japan funds slid sharply. In yen terms, the Morningstar Japan Large-Cap Equity and Morningstar Japan Mid/Small-Cap Equity categories both fell 17.9% in the quarter. Due to the yen's appreciation versus the pound, however, the categories felled much better in Sterling terms, losing 7.7% each.
Morningstar Category | Average Return % |
---|---|
Asia-Pacific ex-Japan Equity | -13.8 |
Asia-Pacific with Japan Equity | -10.3 |
Australia & New Zealand Equity | -11.5 |
China Equity | -23.8 |
Hong Kong Equity | -19.2 |
India Equity | -25.8 |
Japan Large-Cap Equity | -7.7 |
Japan Small/Mid-Cap Equity | -7.7 |
Korea Equity | -16.1 |
Singapore Equity | -14.6 | Taiwan Large-Cap Equity | 3.9 |
Taiwan Small/Mid-Cap Equity | -0.9 |
UK Equity Funds
Like the rest of Western Europe, UK Equity funds had a dismal quarter, though nowhere near as poor as Asia. The Morningstar UK Large-Cap Value Equity category lost the most, down 10.3% in the quarter. The category is home to funds that typically feature higher exposure to the embattled financials sector and lower exposure to more-resilient mining and resources shares than more growth-oriented offerings. On the flip side, UK Large-Cap Growth funds posted a smaller loss of 8.4% for the period.
After posting terrible losses amid mass de-rating in late 2007, small caps appeared to stabilise somewhat in early 2008. The Morningstar UK Small-Cap Equity category fell by an average of 7.7% in the quarter. That's obviously a poor result in absolute terms, but it was the smallest loss of any of the five Morningstar UK Equity categories in the period.
Morningstar Category | Average Return % |
---|---|
UK Large-Cap Blend Equity | -9.7 |
UK Large-Cap Growth Equity | -8.4 |
UK Large-Cap Value Equity | -10.3 |
UK Mid-Cap Equity | -8.9 |
UK Small-Cap Equity | -7.7 |
European Equity Funds
European equity funds did not escape the first quarter's gloom--they performed slightly better than UK equity funds in the quarter in sterling terms, but that reflects the benefit of the euro's appreciation versus the pound in the period. All five Morningstar European equity categories and both of our Europe ex-UK equity categories fell further in Euro terms than the UK did in sterling. This reflects in part their generally lower allocation to the energy sector, which saw continued relative strength amid high oil prices.
Morningstar Category | Average Return % |
---|---|
Europe ex-UK Large-Cap Equity | -9.7 |
Europe ex-UK Small/Mid-Cap Equity | -8.4 |
Europe Large-Cap Blend Equity | -8.6 |
Europe Large-Cap Growth Equity | -8.2 |
Europe Large-Cap Value Equity | -9.1 |
Europe Mid-Cap Equity | -7.6 |
Europe Small-Cap Equity | -7.4 |
US Equity Funds: At the Heart of the Credit Crunch
Despite being the epicentre of the global credit crisis , the US market proved reasonably resilient in the first quarter.* US financials were hit hard, but even then, there was the occasional silver lining. JP Morgan finished the quarter up 8.6% in dollar terms on the strength of its agreement to buy Bear Stearns at a fire sale price, and14% ahead of the US financials sector average. The operations of the large investment and commercial banks are intertwined, making the failure of one to meet its obligations a potentially system-crippling event. In the face of the credit contraction, a slower economy, and declining corporate profits, our five Morningstar US Equity fund categories each fell between 9.1% and 11.4% apiece in dollar terms.
Morningstar Category | Average Return % |
---|---|
US Large-Cap Blend Equity | -9.7 |
US Large-Cap Growth Equity | -10.8 |
US Large-Cap Value Equity | -8.9 |
US Mid-Cap Equity | -11.2 |
US Small-Cap Equity | -11.0 |
Besides encouraging the buyout of Bear Stearns, the Federal Reserve lowered the federal funds rate from 4.25% to 2.25%, lowered the discount rate (the rate at which a limited number of institutions can borrow directly from the Fed) from 4.75% to 2.5%, opened the discount window to investment banks, and reduced the capital holding requirements for Fannie Mae and Freddie Mac, all efforts to unlock the gears of credit. Fed Chairman Ben Bernanke has struggled to provide liquidity in order to encourage borrowing and lending without stimulating inflation. Oil exceeded $100 per barrel during the quarter, and commodities in general surged, magnifying the potentially inflationary results of Bernanke's rate cuts. High oil prices tend to encourage inflation, since they raise the cost of almost all goods and services, but they also tend to depress the economy, as they soak up more and more of consumer and business spending. Therefore, observers wonder if Bernanke will be able to avert the dreaded "stagflation" (simultaneous declining growth and higher prices) of the 1970s.
Emerging Markets Funds Sag
Emerging markets posted a rough quarter, with India and China leading the way down. Eastern Europe also struggled: The Morningstar Emerging Europe Equity category dropped 14.4% in sterling terms. Countries such as Hungary and Turkey suffered from fear of inflation as growth rates slowed. Russia funds, however, proved more resilient as the country's oil and gas revenues cheered investors. The average fund in the Morningstar Russia Equity category fell 8% in the period--poor in absolute terms, but not bad given the overall tenor of the quarter. Latin America funds remained strong, reflecting in part the dominance of the resource-heavy Brazilian economy: The Morningstar Latin America Equity category fell a relatively svelte 4.5% in the quarter.
Morningstar Category | Average Return % |
---|---|
Emerging Europe Equity | -14.4 |
Emerging Europe ex-Russia Equity | -14.5 |
Emerging Markets Equity | -10.6 |
Latin America Equity | -4.5 |
Russia Equity | -8.0 |
Property Funds Mixed
After slumping in 2007, direct property funds were mixed in the first quarter. Those focused on Switzerland showed strong returns, even after adjusting for the Swiss Franc's appreciation versus the pound. However, UK focussed offerings were for the most part still showing losses ranging up to as much as 6% in the period.
Sector Fund Wrap: Gold Rises
Among sector funds, the quarter showed a continuation of one key trend from 2007, but a reversal of another. In the first instance, financials sector funds continued to slump, falling 11.1% on average--an unsurprising result given the ongoing impact of the subprime crisis and the meltdown at Bear Stearns. But two areas of relative strength in late 2007--technology and communications funds--slid slightly more as the uncertainty outlook for the world economy may have begun to impact investor perceptions of future growth opportunities. The Morningstar Sector Equity Technology category fell 13.9% in the period, with the Morningstar Sector Equity Communications category dropping 14.2%.
The Morningstar Sector Equity Precious Metals category lodged he best performance of any sector group, rising 7.4% for the quarter. This largely reflected the run-up in gold prices, which peaked at an intraday high north of 1,033 USD per ounce in mid-March. Prices have fallen sharply since then and were in the mid 880s late Tuesday night, but the rise was still strong enough in the quarter to propel the funds (which largely invest in shares of gold mining companies) up. A rise in gold prices is often associated with inflationary fears and a weakening dollar, both of which were issues in Q1.
Morningstar Category | Average Return % |
---|---|
Sector Equity Biotechnology | -7.8 |
Sector Equity Communications | -14.2 |
Sector Equity Consumer Goods and Services | -7.0 |
Sector Equity Energy | -6.5 |
Sector Equity Financial Services | -11.1 |
Sector Equity Health Care | -8.6 |
Sector Equity Industrial Materials | -2.9 |
Sector Equity Precious Metals | 7.4 |
Sector Equity Technology | -13.9 |
Sector Equity Utilities | -8.6 |
Bond Funds Stand Tall, But Quality Matters
As one would expect, bonds fared considerably better than equities in the quarter, but--for obvious reasons--credit risk was not rewarded. Thus, government-bond funds roundly outperformed corporate-bond offerings, which in turn beat their high-yield counterparts. The average fund in the Morningstar Sterling Government Bond category rose 1.1% in the quarter, but the Morningstar Sterling Corporate Bond category fell 3.33%, and the Morningstar Sterling High-Yield category dropped 4.3%. As the table below shows, the scenario was repeated in across the Euro and Dollar bond categories.
Morningstar Category | Average Return % |
---|---|
Sterling Corporate Bond (in Sterling) | -3.3 |
Sterling Government Bond (in Sterling) | 1.1 |
Sterling High-Yield Bond (in Sterling) | -4.3 |
Euro Corporate Bond (in Euro) | -1.7 |
Euro Government Bond (in Euro) | 0.9 |
Euro High-Yield Bond (in Euro) | -6.8 |
Dollar Corporate Bond (in USD) | 1.8 |
Dollar Government Bond (in USD) | 2.8 |
Dollar High-Yield Bond (in USD) | -1.2 |
All returns in Sterling unless otherwise noted. The segment on U.S. equities was written by John Coumarianos of the Morningstar U.S. Equity Analysis team.