U.S. equity funds post historic gains in 2013: Morningstar

The Morningstar Canada fund indices that measure the aggregate returns of funds in the U.S. equity and U.S. small/mid cap Eequity categories increased by 38.5% and 40%, respectively, during the year. For both indices, 2013 was their best annual performance in 25 years, the longest period for which Morningstar data is available. Additionally, both fund indices beat the standard benchmarks for their respective category, as the large-cap S&P 500 Index and the small-cap Russell 200 Index were up 32.4% and 38.8%, respectively.

“The S&P 500 Index had its best year since 1997 as growth in the U.S. economy gathered steam, and the nearly 7% appreciation of the U.S. dollar relative to its Canadian counterpart added even more to the returns of U.S. equity funds,” says Joanne Xiao, Morningstar fund analyst. “Investors should expect the best performers in that category to be those funds that didn’t hedge their currency exposure and therefore benefited from the rising U.S. dollar.”

Also among the top-performing fund indices in 2013 was the one that tracks the Japanese equity category, which increased by 38.1%. The Nikkei 225 index of Japanese stocks gained nearly 57% when measured in local currency, but because the Japanese yen declined by 12% versus the loonie, Canadian investors didn’t receive the full benefit of the market gain. The fund indices that track the European equity, global equity, and international equity categories increased by 30.8%, 29.9%, and 26.2%, respectively, in 2013.

Canadian equity funds had a solid year on an absolute basis, but they trailed their foreign counterparts significantly. Among the five domestic-equity categories, the best performers were Canadian focused small/mid cap equity, up 23.2%, and Canadian focused equity, up 22%; funds in these two categories allocate more than 20% of their assets to U.S. stocks, on average. By comparison, the purely domestic Canadian small/mid cap equity fund index increased by 21.9%, while Canadian dividend & income equity and Canadian equity funds were up 16.5% and 14.8%, respectively.

“Canadian equity funds in aggregate outperformed the S&P/TSX Composite Index’s 13% increase in 2013 by underweighting the basic materials sector, which is the third-largest sector represented in the index and was the biggest loser this year with a 29% drop. Within the sector, gold producers struggled as the price of gold plunged,” Xiao says. “The best-performing sectors, healthcare and consumer discretionary, together comprise less than 10% of the Canadian market.”

At the top of the rankings was the health care equity fund index with a 49.8% increase, while the worst-performing equity categories were natural resources equity with a 6% decrease and precious metals equity, which was down 48.2%.

Four of the seven fixed-income fund categories were in the red for the year. Funds in the Canadian long term fixed income and Canadian inflation-protected fixed income categories, which respectively decreased by 7% and 12.3%, were hit particularly hard by the increasing yields that resulted from the U.S. Federal Reserve’s plan to taper its bond purchase program.

“The anticipation of the Fed’s tapering, more than the actual tapering, is what led to the increase in bond yields,” Xiao says.

The Canadian fixed income and preferred share fixed income fund indices also ended the year in negative territory, down 1.7% and 2.6%, respectively.

Morningstar Canada’s preliminary fund performance figures are based on 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.