Despite an August swoon in markets, half of the Canadian mutual fund industry managed to eke out positive returns for the third quarter, according to Morningstar Canada.

Morningstar tracks mutual fund performance in 42 fund categories. The best performer was the Asia Pacific ex-Japan equity index, with a quarterly return of 7.3%, fuelled by hot markets in Shanghai and Hong Kong, which were up 45.3% and 24.7% respectively.

“The National Bureau of Statistics in Beijing announced in mid-July that China’s second-quarter GDP came in at an annualized growth rate of 11.9% after a blistering 11.1% during the first quarter,” says Morningstar Canada analyst Philip Lee. “This provided investors, already optimistic about the Chinese economy, with a reason to continue bidding up China-related stocks.”

Lee points out that this growth came despite a 27-basis-point hike by the Chinese central bank aimed at curbing inflation, and the sharp equity correction in the middle of August.

And unlike the mid-summer credit worries of a decade ago, Asian markets also helped boost the emerging markets fund index to a 5% gain. While Asian equities constitute half the assets in emerging market funds, double-digit returns on Brazil’s BOVESPA provided an extra fillip. However, Asian-focused funds with Japanese exposure turned in more subdued gains as the Nikkei dropped 7.5%. In fact, Japanese funds were the worst performers in the third quarter.

Demonstrating what a difference a month can make, gold was swamped during the summer’s liquidity crunch. However, the U.S. Federal Reserve’s September interest rate cut pushed gold back up, leading to a 13.8% gain for the month for the precious metals category and a quarterly return just ahead of Asia-Pacific funds, at 4.5%.

“Gold prices are now hitting multi-decade highs,” Lee explains. “And with a still-shaky U.S. economy, the stage is set for possible additional rate cuts. This has been a boon to bullion producers and their stock prices as the spot price for gold closed above $740 at the end of September — a gain of more than 11% for the quarter. This also helped to boost prices of other precious metals, such as silver and platinum.”

While Europe was also hard hit by sub-prime woes, the rising loonie contributed to a negative quarter for both international and global equity funds.

“Overall, the ascent of the loonie versus many major currencies continues to erode the returns of foreign funds with unhedged exposures,” Lee adds. “It’s difficult to predict which way the Canadian dollar will move going forward, but it probably makes less sense to hedge foreign currency exposures back to Canadian dollars now because of the loonie’s strong run.”

Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com.

(10/02/07)