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In 2008, anything with a whiff of risk was roundly shunned by investors. Small-cap equities fared poorly, emerging markets bombed, and investors favoured defensives such as consumer staples and health care over cyclicals. While market volatility suggests investors still have reason to be cautious, risk isn't quite the dirty word it was a few short months ago. Backed by firming oil and metals prices, key emerging markets have moved up. Small and mid-caps across the board are faring better on a relative basis. Even junk bonds (euphemistically known as "high-yield") have fared well.
To be clear, we are not suggesting investors have returned to the free-wheeling pre-credit crunch mentality or anything even close to it. However, it does appear that they are finding enough value in certain areas to take on incrementally more risk than was the case in 2008.
Sector Fund Performance: Gold glitters, tech and cyclicals strong; financials, property slump
The Morningstar Sector Equity: Precious Metals category delivered by far the best performance of any sector-specific fund group in 1Q. This largely reflects an increase in gold prices during the period as most funds in the category invest primarily or exclusive in the equities of gold mining companies. Other strong performing Morningstar Sector Equity fund categories included Technology (up 1.6%), Industrial Materials (down 0.3%), and Energy (down 3.6%). Conversely, two defensive areas underperformed: the average health care fund lost 7.4%, whilst the average Consumer Goods & Service Fund fell 9.2%. But if investors were ready to take on some additional risk, they still avoided areas at the centre of the credit crunch: The worst performing Morningstar Sector Equity fund categories in 1Q were Real Estate: Indirect, Financial Services, and Real Estate: Indirect - Europe. Funds in these categories lost 20.4%, 18.7%, and 17.3% on average.
| Morningstar Category | Total Ret 3 Mo (Qtr-End) GBP | Total Ret 3 Mo (Qtr-End) EUR | Total Ret 3 Mo (Qtr-End) USD | Total Ret 3 Mo (Qtr-End) JPY |
|---|---|---|---|---|
| Sector Equity Precious Metals | 13.30 | 18.26 | 12.96 | 23.07 |
| Sector Equity Technology | 1.62 | 6.06 | 1.31 | 10.38 |
| Sector Equity Industrial Materials | -0.25 | 4.11 | -0.56 | 8.35 |
| Sector Equity Biotechnology | -3.39 | 0.84 | -3.69 | 4.94 |
| Sector Equity Real Estate Direct - Germany | -3.46 | 0.76 | -3.76 | 4.86 |
| Sector Equity Energy | -3.57 | 0.65 | -3.87 | 4.74 |
| Sector Equity Real Estate Direct | -5.52 | -1.39 | -5.81 | 2.62 |
| Sector Equity Health Care | -7.35 | -3.30 | -7.64 | 0.64 |
| Sector Equity Other | -7.99 | -3.96 | -8.27 | -0.05 |
| Sector Equity Communications | -8.73 | -4.74 | -9.01 | -0.86 |
| Sector Equity Consumer Goods and Services | -9.24 | -5.27 | -9.52 | -1.42 |
| Sector Equity Real Estate Indirect - Asia | -10.05 | -6.11 | -10.32 | -2.29 |
| Sector Equity Utilities | -14.26 | -10.51 | -14.52 | -6.86 |
| Sector Equity Real Estate Indirect - Europe | -17.29 | -13.67 | -17.54 | -10.16 |
| Sector Equity Financial Services | -18.67 | -15.11 | -18.92 | -11.66 |
| Sector Equity Real Estate Indirect | -20.43 | -16.95 | -20.68 | -13.57 |  |
Select Emerging Markets Rebound: Russia, Latin America show strength
The sector trends in the quarter are highly evident in the performance of funds focussed on different regions. This is especially true in emerging markets, which saw Russia and Latin America funds deliver strong returns. The average fund in the Morningstar Russia Equity category returned 8.8% and held a near-60% combined stake in energy and industrial materials (the latter is in this case mostly made up of metals and mining issues). Similarly, the average fund in the Morningstar Latin America Equity category rose 3.5% in the period and held just over 30% combined in energy and industrial materials.
| Morningstar Category | Total Ret 3 Mo (Qtr-End) GBP | Total Ret 3 Mo (Qtr-End) EUR | Total Ret 3 Mo (Qtr-End) USD | Total Ret 3 Mo (Qtr-End) JPY |
|---|---|---|---|---|
| Russia Equity | 8.79 | 13.55 | 8.45 | 18.17 |
| Taiwan Small/Mid-Cap Equity | 7.89 | 12.61 | 7.56 | 17.19 |
| Taiwan Large-Cap Equity | 7.37 | 12.07 | 7.05 | 16.63 |
| China Equity | 5.26 | 9.87 | 4.94 | 14.34 |
| Latin America Equity | 3.45 | 7.98 | 3.13 | 12.37 |
| Greater China Equity | 2.33 | 6.80 | 2.01 | 11.15 |
| Emerging Markets Equity | -1.37 | 2.94 | -1.67 | 7.13 |
| Hong Kong Equity | -1.99 | 2.30 | -2.29 | 6.46 |
| ASEAN Equity | -4.42 | -0.24 | -4.71 | 3.82 |
| Malaysia Equity | -4.70 | -0.53 | -4.99 | 3.52 |
| India Equity | -5.89 | -1.77 | -6.18 | 2.23 |
| Emerging Europe Equity | -7.87 | -3.84 | -8.16 | 0.07 |
| Emerging Europe ex-Russia Equity | -16.85 | -13.21 | -17.11 | -9.68 | |
The remainder of emerging Europe didn't fare nearly as well. Indeed, the average fund in the Morningstar Emerging Europe ex Russia category lost 16.9%, reflecting investor concern over risks in these smaller markets. China funds rose, with the average fund in the Morningstar China equity sector gaining 5.3% in the period on the back of a strong stimulus package, whilst India funds fell an average of 5.9% given a lack of stimulus and investor concerns regarding upcoming elections in the country.
