Fund Performance Review (2Q2006)

Inflation is higher than central banks would ideally like. Monetary tightening is an increasing global phenomenon, and in turn, has been the predictable response ....

Morningstar Analysts 02 August, 2006 | 0:00
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Inflation is higher than central banks would ideally like. Monetary tightening is an increasing global phenomenon, and in turn, has been the predictable response. The increased cost of leveraged trades triggered a wave of global equities sell-off from multiyear highs. With the US, Europe, Japan and China all set to subdue inflation by raising rates, markets experienced a violent turbulence on positions involving carry trades, especially in emerging markets. The unwinding of speculative trades and profit-taking positions, specifically in commodities markets, has certainly contributed to stock price declines. The downturn offset much of the gains from the first quarter, and is likely to continue if investors rea

llocate their substantial oversea investments back home to the US. All these explained why three of the top-10 performing categories belong to the traditional safe-havens such as money market and fixed income.

Top-10 Performing Fund Categories
Generally, lack of clear direction is never a market friendly message to investors. However, uncertainty to do with the inflation outlook and the US rate hike is likely to continue to plague the market sentiment. Short-term volatility is expected as the market is still looking for the right wavelength to read the mind of the new Chairman Ben Bernanke, particularly given some of the communications missteps that have occurred. The leading performer of the second quarter went to Money Market ex-HKD/USD surprisingly where the category average grew nearly 6.4 percent. It was indeed an underperforming category last quarter, generating a merely 0.86 percent return. However, it served as a safe-haven and investors started jumping on the bandwagon.

Should the rate go up, investment would be switched to where a higher return rate is offered. The effects of higher interest rates and oil prices appear to have eroded corporate earnings and thus weakened the economy as a whole. The UK Fixed Income Category, the last category with positive returns on average during the first quarter, now ranked the third with a 4.31 percent return. The Europe Fixed Income Aggregate category - also one of the bottom 10 categories in the first quarter - posted a 4.74 percent return, trailing the leading category by less than 2 percent. For the first time since August 2000, the Bank of Japan raised its overnight call rate by 25bps, putting it at 0.25 percent to end the nation's 6-year old zero interest rate policy. The Japan Fixed Income category, the second worst performer in the first quarter with a negative 1.62 percent return, now jumped into the top 10 categories, finishing the quarter with a 2.4 percent return.

The China Equity Category - the best performer in the first quarter - slipped significantly. In terms of China's macro, it remains unstoppable. The 2Q06 GDP reported another double-digit performance which will surely catch the Chinese officials by surprise. Having said that, China has already been implementing austerity measures and the property sector already plummeted. The China Equity category, which posted a strong 24.7 percent return in the first quarter, was now lowered to just a 2.4 percent return. Speculation on RMB appreciation continued and China's Foreign Exchange reserve amounted further to USD 941 billion in June. The China plays remain the hottest topic in the emerging market. The iShares FTSE/Xinhua A50 China Tracker fund was now the dominating leader in China equity.

The Australian economy has outperformed in the past few months, as economic activity has gone from strength to strength, nullifying any market concerns. The economy added 52,000 jobs in June, leaving the unemployment rate at 4.9%. The metal market rebound also helped send the Australian dollar higher. The Australia, New Zealand Equity was the best performing equity fund category in this quarter to close with a 3.6 percent return.

Bottom 10 Performing Fund Categories
With liquidity coming into Asia, India and China names ran up the greatest year-to-date returns. However, they would be the most vulnerable should liquidity disappear regardless of how well the underlying economy is doing. Foreign funds already pulled nearly USD3 billion out of Indian equity market since the Sensex began tumbling in May. India Equities experienced a free fall jumping from a 21.9 percent return - the second best category in the first quarter - to the worst performing category in the second quarter with a 16.5 percent loss. Five India Equity funds were found in the bottom 10 leagues with four of them taking up the top spots in the table.

Usually, the rising of small/mid cap stocks are the early signals in a recovering economy; however, the Japan Small/Mid Cap Equity remained vulnerable to the soaring oil price and probable rate hike cycle. The category lost 13.15 percent on average during the second quarter which was six times worse than it was in the first quarter. Very much like the Japan Small/Mid Cap Equity, the North America Small/Mid Cap Equity and the Global Small/Mid Cap Equity also posted a 5.1 percent and a 4.8 percent loss respectively in this quarter.

As signs show liquidity is leaving emerging markets, the Korea Equity recorded a 3.9 percent loss, despite the KOSPI rising substantially since the first quarter. Latin American Equity funds finished a short spell honeymoon in the last quarter, now slumping from a positive 17.2 percent to a negative 4.0 percent this quarter. In fact, the year of 2006 is an election year in Latin America. The Mexico and Brazil elections all weighed in on market sentiment.

Editorial & Research Team, Morningstar Asia Ltd. can be reached at hksupport@asia.morningstar.com
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