After a poor showing in the first three months of 2008, investment funds that focus on foreign equities suffered more losses in the second quarter, according to preliminary performance data released today by Morningstar Canada.

Rising commodity prices, inflation fears and persisting concerns over the health of the economy in the United States drove many of the world’s markets down over the last three months, particularly in June.

Practically all foreign equity categories were in the red for the quarter, with losses ranging from 1.8% for the emerging markets equity fund index to 4.7% for the Asia Pacific equity fund index. The only sector-diversified foreign equity categories to post gains were U.S. small/mid cap equity with 2.5% and Japanese equity with 0.3%.

But the funds that were hit hardest were those that target the financial sector, as the credit crisis continued to play havoc. The financial services fund index lost 7.7% for the quarter and 10% for the month of June alone. For both periods these were the worst returns among the 42 Morningstar Canada fund indices. Also affected was the real estate equity fund index, which lost 6.5% for the quarter and 8.2% in June — second worst in both cases.

“The plight of financials worsened in June, particularly in the U.S., where the financials subindex of the S&P 500 dropped almost 19% (in US dollars),” says Jordan Benincasa, fund analyst for Morningstar Canada. “Optimists had looked for a short and shallow period of firms purging bad loans, but it became a protracted credit crunch that crimped or eliminated profits of companies well beyond Wall Street banks.”

While skyrocketing commodity prices represent cost increases — and tightening profit margins — to many of the world’s economies, they are a boon to the resource-rich Canadian market. The natural resources equity fund index had the best overall return in the second quarter with 14.2%, followed by the Canadian equity and Canadian income trust equity fund indices, up 9.1% and 8.3%, respectively.

“These stellar returns stem from global thirst for energy, metals and agricultural commodities,” Benincasa said. “Oil crossed the US$140-per-barrel threshold in late June, which helped drive up the prices of cheaper alternatives like coal and natural gas. Moreover, demand for industrial metals such as iron ore and copper has not abated.”

Another effect of rising food and energy prices was an increased demand for inflation-protected securities, which benefited funds in the Canadian inflation-protected fixed Income category. That group’s fund index rose 3.5% for the quarter, easily the best return among fixed-income categories in this climate where many investors expect central banks to hike interest rates to curb inflation. But Benincasa warns that yields have fallen sharply, which could limit these funds’ upside and make them a less than ideal place to park new money.

Final performance figures will be published next week.