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US equity funds outperform again in 2014, says Morningstar Canada

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Mutual funds in Canada offered generally positive results in 2014, despite a sharp increase in volatility in the last four months of the year. 

Thirty-nine of the 42 Morningstar Canada Fund Indices, which measure the aggregate returns of funds in various standard categories, increased for the year overall. As was the case in 2013, funds that invest in US equities were among the best performers, according to preliminary data today released by Morningstar Canada.

The fund index that tracks the returns of funds in the US Equity category increased by 17.3% during the year, reflecting a 13.7% gain for the benchmark S&P 500 Index as well as an 8.3% depreciation of the Canadian dollar versus its US counterpart. The Morningstar US Small/Mid Cap Equity Fund Index was also among the top performers with an 11.6% increase over the past 12 months.

"An accelerating US economy, high corporate profits, and patient monetary policy by the Federal Reserve, with a carefully calibrated winding down of its enormous bond-buying program, all helped the S&P 500 reach new highs over the past year," says Morningstar Manager Research Analyst Vishal Mansukhani. "The slide in the price of oil, a major export for Canada, was one reason for the depreciation in the loonie. An expectation that the US Federal Reserve will lift rates before the Bank of Canada also hurt the loonie, as the anticipation of rate increases can spur demand for the currency of that country."

Unlike the previous year, 2014 was a very good year for bond funds, as all seven fund indices that track fixed-income categories were in the black. Most impressive was the Morningstar Canadian Long Term Fixed Income Fund Index, which finished the year with a 17.1% increase, while the Canadian Fixed Income and Global Fixed Income Fund Indices were up 6.9% and 6.8%, respectively.

"Canadian sovereign, provincial, and corporate bonds returned 8.7% in 2014, as measured by the Bank of America Merrill Lynch Canada Broad Market Index, versus 6.1% and 7.6% for the comparable US and global bond indexes, respectively," says Mansukhani. "Although the US economy fared well in 2014, growth in other major economies sputtered, increasing the demand for safe-haven securities like Canadian bonds. Also, despite economists' expectations that rates on 10-year Canadian government bonds would rise by about 50 basis points, the year ended with rates being almost 1 percentage point lower. Along with increased demand for Canadian government bonds from foreigners, lower inflation and tumbling gas prices were tailwinds for bond rates."

Sector-specific funds found themselves both at the top and bottom of the performance table in 2014. Among the best performers were the Real Estate Equity and Financial Services Equity Fund Indices with increases of 13.6% and 12.2%, respectively, while the two worst performers were Natural Resources Equity and Energy Equity, down 10.7% and 11.1%, respectively.

Despite a difficult spell that started in September, diversified Canadian equity funds ended the year with solid results. The Morningstar Canadian Equity Fund Index increased by 10.4% over the past 12 months, in large part because of the strength of the financial services sector. The slumping energy sector, which represents a significant portion of the Canadian market, dragged results.

"Oil prices fell to a five-year low because of increased supply from US shale oil production, weaker demand from Europe and China, and OPEC's refusal to cut production amid this supply-demand dynamic. Falling oil prices are a huge headwind for the Canadian oil and gas sector, which has one of the highest production costs in the world," says Mansukhani.

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