On the heels of their best calendar-year performance in more than 15 years, investment funds in Canada posted mostly negative returns for the first month of 2010.

Thirty of 43 fund indices lost ground in January, including all but three of the 24 indices that track equity fund categories, according to preliminary performance data released Tuesday by Morningstar Canada.

The precious metals equity fund index was the worst performer for the month with an 8.1% loss.

Global equity markets had a promising start to 2010, but midway through the month government initiatives in China and the United States contributed to their reversal in course.

“The People’s Bank of China raised the reserve requirement for depository financial institutions to rein in liquidity, and interest rates increased slightly in what may be the beginning of a larger trend to start taming inflation,” says Esko Mickels, fund analyst for Morningstar Canada.

“Meanwhile, President Obama announced his intention to prevent further consolidation in the U.S. financial system by introducing the ‘Volcker Rule,’ which is intended to restrict banks from owning, investing in, or sponsoring hedge funds, private equity funds, or proprietary trading operations if they are unrelated to serving their customers. This weighed on U.S. banks as well as Canadian banks with U.S. operations.”

“As a result, equity markets witnessed a partial unwinding of the risk trade in the second half of January, and last year’s top-performing fund categories, which are also among the riskiest, suffered,” Mickels says.

Along with precious metals equity, the biggest decliners were greater China equity (-7.1%), Canadian equity (-5.4%), Asia Pacific ex-Japan equity (-4.9%) and emerging markets equity (-4.8%). “Concern about China’s monetary policy moves dented commodity prices, which hurt both Asian and Canadian equities.”

The Canadian equity category’s loss essentially matched that of Canada’s main market benchmark, the S&P/TSX Composite Index, which dropped 5.3%. Among other domestic equity fund indices, losses ranged from 0.4% for the Canadian income trust equity fund index to 4.5% for Canadian focused equity.

Foreign equity funds, though mostly in the red, did not lose as much as their respective benchmarks thanks to the Canadian dollar’s depreciation against many of the world’s major currencies.

One exception to the equity rout was the Japanese equity fund index, which advanced 3.8% despite the Nikkei falling 3.3% for the month. “The gain was made possible by a 4.8% rebound in the yen versus the Canadian dollar, after it had fallen by 8.5% in December,” Mickels said.

The only other equity fund indices to post gains for the month were health care equity and real estate equity, which returned 1.3% and 0.8%, respectively.

Risk aversion and the decline of equity funds left fixed-income funds to pick up the slack. The Canadian long term fixed income fund index was the second-best performer overall with a 2.6% gain, followed by Canadian fixed income and high yield fixed income with 1.8% each.

Final performance figures will be published next week.

IE