Equity funds in Canada had one of their worst years ever in 2008, as markets around the world braced for what could be a painful recession.

All of the fund indices that track either equity or balanced fund categories had negative returns for the year, according to preliminary performance data released Monday by Morningstar Canada.

For 23 of the 24 equity fund indices, the losses exceeded 20%, and all but four of them recorded their worst calendar-year return in at least 25 years. The best performing equity fund indices for the year were health care equity (-8.4%) and Japanese equity (-20%), while the worst was natural resources equity (-48.5%).

“Oil and commodity prices tumbled in 2008 as a result of dwindling global demand,” said Jordan Benincasa, fund analyst with Morningstar Canada, in a release. “Natural resource stocks took a beating as oil went from more than US$145 per barrel to less than US$40, while other commodities like natural gas, aluminum and copper followed a similar path.”

Falling commodity prices also impacted funds that focus on small-cap equities: the Canadian focused small/mid cap equity fund index lost 48.2% for the year, while Canadian small/mid cap equity and global small/mid cap equity dropped 41.6% and 40.6%, respectively. Emerging markets equity funds, which also hinge on resources to a large extent, collectively lost 45.9%. The drop casts serious doubt on the decoupling theory, which purports that countries like China and India are no longer dependent on the economic health of the United States, Morningstar said.

In the U.S., the S&P 500 Index plunged 37% in 2008 amid the most severe financial crisis since the Great Depression. But for Canadian holders of U.S. equity funds, the losses were mitigated by the Canadian dollar’s sharp depreciation against the U.S. currency. The U.S. equity and U.S. small/mid cap equity categories were down 29.3% and 30.6%, respectively, for the year.

Fixed income fund indices were the only ones able to provide positive returns in 2008. The global fixed income fund index posted the highest gain overall (15.6%), helped by the loonie’s dramatic decline, which in turn was mainly caused by plunging commodity prices. “The past year should serve as a reminder that unhedged global bond funds can act as a nice diversifier for those with heavy exposures to the natural resources sector,” Benincasa said.

Domestic bond funds did not fare as well, though most indices were up for the year; Canadian short term fixed income gained 5.3%, Canadian fixed income gained 2.2% and Canadian long term fixed income was up 1%. “As markets continued to spiral downwards, investors flocked to the safety of short-term fixed income securities,” Benincasa said. “The demand for these securities has hit a point where investors are willing to accept historically low yields in order to avoid further losses.”

This rising demand for risk-free securities punished funds in the high yield fixed income category, which collectively lost 21.5% last year. “High-yield bonds were clobbered as investors demanded to be paid more for assuming higher risk,” Benincasa said.

Among the 11 balanced and target-date fund categories, the losses for the year ranged from 8% for the 2010 Target Date Portfolio Fund Index to 23.4% for the global equity balanced fund index.

Preliminary fund performance figures are based on the change in funds’ net asset values per share during the month, and do not necessarily include end-of-month income distributions. Final performance figures will be published next week.

IE