Funds investing in stocks based in the world’s emerging markets offered the best returns for July, according to preliminary data on investment-fund performance released today by Morningstar Canada.

July was a strong month for the mutual fund industry, with 28 of the 31 Morningstar Canada fund indices gaining ground. The Morningstar Canada emerging markets equity fund index was up 3.6% for the month, as investors seemed to show renewed confidence in these markets following a massive selloff in May. The health-care fund index had the second best return with 2.9%.

After a two-month hiatus, funds that focus on Canadian commodities resumed their winning ways in July, amid above-normal temperatures that caused natural gas prices to soar. The natural resources fund index gained 2.9%, while Canadian income trust — which has a sizeable energy component — and precious metals were up 2.6% and 2.5% respectively. The financial services fund index also performed well, ranking eighth overall with a 2.3% return.

“As has been the main story for the past several years, resources and financials were the key drivers of the Canadian equity markets in July,” said Morningstar Canada senior analyst Brian O’Neill. “Materials stocks were especially strong, with the S&P/TSX capped materials index up more than 4%. Feverish merger-and-acquisition activity in the mining sector was a huge factor, along with a 4% rise in the price of gold and buoyant base metals prices. On the energy front, a late stock price surge from the likes of Encana, Suncor, Talisman and Canadian Oil Sands Trust helped push up the S&P/TSX Capped Energy Index just over 1%.”

Among the major equity categories, the European equity fund index was the best performer in July with a 2.4% gain, while Asia, excluding Japan, equity returned 2.3%. The performance of these two regions contributed to the success of the International Equity fund index, which gained 2% for the month.

“International equity funds have outperformed Canadian equity funds so far in 2006,” O’Neill noted. “This is largely due to the strength of the European markets, with the european Equity fund index up 12% year to date. Along with solid individual market returns from France, Germany and the UK, a 4% rise in the euro and a 5% rise in the pound versus the loonie have given these funds a huge boost.”

The worst performing fund index for the month of July was U.S. small and mid-cap equity, which suffered a 3.6% loss. Science and technology was second worst, down 2.8%.

“Despite the U.S. dollar’s strengthening 1.5% versus the loonie, the U.S.-heavy science and technology funds fell again in July,” said O’Neill. “Stock price weakness in key tech companies such as eBay, Yahoo, Dell, Google and Nortel contributed to the poor performance of these sector funds.”

“The U.S. small and mid-cap equity funds have struggled amid substantial, recent global volatility,” O’Neill added. “In July, these funds were hurt by the resource resurgence since most of them have only moderate exposure to the energy and materials sectors. Also, many have more than 20% exposure to technology, which has continued to flounder.”

Following back-to-back losses in May and June, the Canadian equity fund index posted a solid 1.6% return in July. The Canadian Equity (pure) fund index gained 1.8%, which mirrors the return of the S&P/TSX Composite Index for the month. Funds in the Canadian small cap Equity category did not fare as well as their larger cap counterparts, but their fund index still gained a respectable 1%.

After three consecutive months in the red, Canadian income funds produced decent returns in July. The Canadian bond, Canadian dividend and Canadian income balanced fund indices, which represent the three best-selling fund categories in the country for the first half of the year, gained 2%, 1.9% and 1.9% respectively.

The Morningstar Canada fund indices measure the dollar-weighted return of assets in Canadian investment funds for each of 31 industry fund categories. The fund indices are the only fund benchmarks that correct for “survivorship bias” by including the impact of historical data from discontinued funds — those that no longer exist because of mergers, mandate changes or terminations.