Mutual funds from across most categories seemed headed for a very solid month in July. But on July 20, and during the ensuing week, worries gripped world markets and caused several stock indices to decline — many by more than 6%.

As a result, most of the Morningstar Canada fund indices that focus on equities ended the month in the red, according to preliminary fund performance data released today by Morningstar Canada.

“Investors were spooked by a stream of bad news during that week, and that sent the markets on a white-knuckle ride,” said Morningstar Canada analyst Bhavna Hinduja, in a release. “A weakening U.S. housing market, spreading sub-prime mortgage problems, high crude oil prices and concerns over a slowdown in the world economy were the primary drivers of the negative sentiment that led to a sell-off in most equity markets.”

In an unusual twist, precious metals funds were hit hardest by the correction, with the precious metals equity fund index losing 7% between July 20 and July 27. But because the fund index had already accrued a 9.8% gain before the correction, and thanks to a rebound on the last two days of the month, it ended July with a gain of 4.3%, the second best return among the 42 Morningstar Canada fund indices.

For the second month in a row, the Asia Pacific ex-Japan equity fund index was the best performer among all fund indices in July, with a gain of 5.3%. China and South Korea were the main contributors to this performance with monthly returns of 17% and 10.9% respectively for the Shanghai Stock Exchange composite index and the Korea composite stock price index.

China’s strength also buoyed the emerging markets equity and Asia Pacific Equity fund indices, which finished the month in third and fourth place with returns of 4.2% and 2.3% respectively. Rounding out the top five was the Japanese equity fund index, which gained 1.3% despite the Nikkei 225 index losing 4.9% for the month. Funds in that category that don’t hedge their currency exposures benefited from a 3.6% appreciation of the yen versus the Canadian dollar.

In Canada, the week-long correction essentially nullified the gains that the stock markets had accumulated in what was shaping up to be a very promising month. The S&P/TSX composite ndex dropped 5.9% from July 20 to July 7 and finished the month down 0.1%. This was reflected in the performance of the Canadian equity fund index, which was looking at a 4.5% month-to-date gain on the morning of July 20 but closed the month down 0.4%. Similarly, the Canadian small/mid cap equity fund index was up 5.1% before the correction but ended up losing 0.2%.

During that fateful week, Canada’s three major sectors — energy, financials and materials — lost 6.5%, 4.9% and 6.7%, respectively. But for the month as a whole, the S&P/TSX energy and materials sub-indices were able to recover while the financials sub-index ended up losing 2.9%. As a result, funds in the natural resources equity category, most of which invest predominantly in Canada, collectively gained 1.1% in July. Meanwhile, the financial services equity fund index finished third from the bottom with a 3.7% loss.

Canada’s woes in the financial sector pale in comparison to those currently afflicting the U.S., particularly in the real estate industry. As of June 30, the average financial services equity fund had 29.4% exposure to the U.S. while the average real estate equity fund invested 17.5% of its assets south of the border. The real estate equity fund index was the worst overall performer for the second month in a row in July with a 4.8% loss, on the heels of its 7% drop in June.

“Wall Street was in mayhem as heightened concerns over credit markets battered stocks,” Hinduja said. “U.S. markets also reacted negatively to the losses reported by several hedge funds as investors remain uncertain about when the turmoil in the credit markets will end or how much damage it will ultimately cause.”

While no U.S. sector lost more than financials, eight of the 10 sub-indices that make up the S&P 500 were in the red in July, and the index itself lost 3.1% for the month. But broad-based U.S. equity funds fared even worse, with the U.S. equity and the U.S. small/mid cap equity fund indices shedding 3.5% and 4.1% respectively, ranking fourth and second from the bottom. Between July 20 and July 27, these two indices lost 4.9% and 6.3%.

@page_break@The European equity markets also suffered from the mid-month correction, as the German DAX lost 6.8% during that week and 5.3% for the month. London’s FTSE 100 and Paris’s CAC 40 suffered similar losses. The euro’s appreciation versus the loonie during the month curbed some of the damage, but the European equity fund index still ended the month down 2.7%.

Final performance figures will be published on next week.