Go ahead and open the latest quarterly statements from your mutual funds when they arrive. It’ll likely be painless, just like it was a quarter ago. And the quarter before that. And the quarter before that.
Nearly all types of mutual funds made money last quarter, powered by continued gains in stock and bond markets around the world. Everything from plain-vanilla bond funds to broad stock-index funds to potentially risky emerging-market stock funds rose from April through June. Of the 105 fund categories that Morningstar tracks, 99 posted gains in the second quarter. And the handful that lost money are generally niche funds that rarely play more than a supporting role in an investor’s portfolio.
That means making money was easy last quarter for most mutual-fund investors: All they had to do was make sure not to sell. It’s been largely the same trend for years, with only a few hiccups since the stock market bottomed in March 2009 following the financial crisis. Last quarter was the sixth straight quarter of gains for the Standard & Poor’s 500 index, the benchmark for many stock mutual funds.
A look at some of the trends that drove performance:
EMERGING-MARKET FUNDS HAD A RESURGENCE
Worries were so strong last year about some developing economies that Wall Street came up with another catchphrase for them: the Fragile Five. Investors fretted that Brazil, India, Indonesia, Turkey and South Africa would struggle in particular as the Federal Reserve began easing on the accelerator of economic stimulus. Emerging-market stock funds lost 0.1 percent in 2013, which doesn’t sound terrible but was way below the 32.4 percent return of the S&P 500.
But emerging-market stock funds have rebounded, and returned 6.6 percent last quarter. That beat the 5.2 percent return of the S&P 500. A surge in Indian stocks led the way. Investors are hopeful the country’s new prime minister, Narendra Modi, can drive through reforms that will invigorate its economy. Indian stock mutual funds returned an average of 17.3 percent last quarter.
Funds that invest in bonds from emerging markets similarly got back up off the canvas after a tough 2013. They returned an average 4.4 percent last quarter, the second-best performance of the 32 bond-fund categories that Morningstar tracks. They lost an average of 7.3 percent last year.
WERE REPORTS OF THE DEATH OF BOND FUNDS WRONG OR EARLY?
In January, much of Wall Street was forecasting that bond mutual funds were due to decline. The bond market was coming off its first losing year since 1999, and most analysts expected interest rates to rise. When interest rates rise, prices for existing bonds fall because their yields suddenly become less attractive.
However, interest rates dropped, and all 32 categories of bond funds that Morningstar tracks made money in the second quarter.
The biggest gains came from funds that invest in long-term Treasurys and other government bonds. Long-term bonds get the biggest boost from drops in interest rates because their yields are locked in for a longer time period, just as they feel the most pain when rates climb.
Even though the market went against their expectations in the first half of the year, most bond-fund managers still expect rates to eventually rise. A strengthening economy will push up rates, the thinking goes.
VALUE-STOCK FUNDS LED THE WAY
The S&P 500 index has set a record high more than 20 times this year, which has made some investors nervous because stock prices are rising faster than corporate profits.
That’s enhanced the allure of value stocks – ones that are selling at lower prices relative to their earnings than the rest of the market. Value stocks also tend to have higher dividend yields.
In the second quarter, value-stock funds of all sizes beat their growth counterparts. The disparity was starkest among funds that focus on the stocks of medium- or small-sized companies. Small-cap value-stock funds returned 2.9 percent, for example, versus 0.6 percent for small-cap growth funds.
Investor interest is also clearly split: They put $972 million into small-cap value-stock funds through the first five months of the year, while pulling $2.4 billion out of small-cap growth funds.
SMALLER-COMPANY STOCKS LAGGED
Smaller-company stocks had smaller gains during the second quarter than big-company stocks, a break from prior years. Funds that invest in a mix of small-cap growth and value stocks returned 2.3 percent, for example. Their large-cap corollaries returned double that, 4.6 percent.
Many fund managers have been saying they expect large-cap stocks to begin leading the market. That’s because small-cap stocks became relatively expensive after years of outperforming the market. Stocks in the small-cap S&P 600 index trade at 19 times their expected earnings per share over the next 12 months, for example. Stocks in the large-cap S&P 500 index have a lower price-to-expected-earnings ratio of 16.
MUNICIPAL BOND FUNDS CONTINUED THEIR REBOUND
Investors last year wanted nothing to do with bonds issued by local governments, even if their income is free from federal income taxes. Firstly, worries about rising rates hurt them. Secondly, concerns about the financial health of Detroit, Puerto Rico and other issuers spooked the market. Investors yanked money out of municipal-bond funds for 10 straight months from March through December, which forced some managers to sell bonds to raise cash.
But municipal-bond funds rebounded this year, as interest rates fell and default rates remained low. The largest category of municipal bonds by assets, intermediate-term national funds, returned an average of 2.1 percent in the second quarter.