Funds in the first quarter: Foreign markets were first

By Stan Choe
AP Business Writer

NEW YORK (AP) — Anyone with an American-only 401(k) account missed out in the first quarter.

Funds that own stocks from Latin America, Asia and other foreign markets were some of the best performers during the first three months of the year. Hundreds had returns that were more than double those of the most popular U.S. stock funds, which were no slouches themselves. The largest U.S. stock fund had one of its best quarterly performances in years.

It was all part of a strong start to the year for funds in general. Not only did stock funds of all types power higher, so did bond funds. Just over 93 percent of all the funds tracked by Morningstar had positive returns in the first quarter, as of last Wednesday.

Fortunately, more investors seem to have taken advantage. Money poured into stock funds in the final months of 2016, mostly focused on the U.S. market due to excitement that a Republican-led Washington would usher in business-friendly policies.

Here’s a look at the trends that helped shape the quarter for mutual funds and exchange-traded funds. All of the return figures are through last Wednesday.

— Foreign led the way

For years, foreign stock funds did nothing but frustrate. Every peek higher would inevitably give way to another tumble, and the largest foreign-stock fund returned less than 1 percent annualized for the decade through 2016. What made the ride even more frustrating was that U.S. stocks nearly doubled over the same time, after including dividends.

Even with the mediocre performance, many investors continued to buy foreign stocks, looking for ways to diversify their portfolios. Yes, U.S. stocks had been on top for a long time, but they likely couldn’t stay that way forever. And foreign stocks were looking cheaper than their U.S. counterparts by several measures, following the split in performance.

That patience was rewarded in the first quarter, and Vanguard’s Total International Stock Index fund returned 9.2 percent for its best quarter in nearly four years. Returns were even bigger for the types of funds that have been the most frustrating recently: those that invest in emerging markets.

The dollar’s falling value in the first quarter helped, because it meant returns denominated in South Korean won or Mexican pesos were worth more in dollars. The MSCI Emerging Markets index returned 8.8 percent in their local currencies, but 13 percent in dollar terms.

— Still strong in the U.S.

Foreign stock funds may have overshadowed their U.S. counterparts, but both delivered in the first quarter.

The largest U.S. stock fund returned 5.6 percent, for example. That’s the second-best performance in the last three years for Vanguard’s Total Stock Market Index fund.

The job market continues to improve, and optimism has been surging for shoppers and businesses. Corporate earnings, meanwhile, are on the rebound, which has helped push stock prices higher. In the background have been hopes for help from Washington, such as cuts in taxes and looser regulations for businesses.

Funds that own larger stocks generally had better returns during the quarter than smaller-stock funds. Managers who focus on stocks with the fastest sales and earnings growth were also particularly strong.

Transamerica’s Capital Growth fund returned 16.3 percent, for example, one of the top performances for U.S. stock funds in the quarter. Three of its five biggest investments jumped more than 20 percent during the quarter: Facebook, Illumina and Tesla.

— Bond funds chug along

Many investors were bracing for losses from their bond funds as the calendar flipped into 2017.

That’s what happened at the end of last year, after all. The average intermediate-term bond fund, which forms the core of many portfolios, lost 2.5 percent in the fourth quarter as interest rates jumped. When rates rise, prices for existing bonds fall because their interest payments are less attractive than those of newly issued bonds.

And rates rose sharply late last year on expectations that the Republican sweep of the White House and Congress would lead to faster economic growth and inflation. The Federal Reserve is also back to raising interest rates, after keeping them at a record low for seven years following the 2008 financial crisis.

But even after the Fed raised rates at its most recent meeting a couple weeks ago, rates actually sank. The Fed has stressed that it plans on moving gradually and modestly, perhaps even more so than many investors had been expecting. If it follows that script, bond fund managers say losses may not be inevitable.

The average intermediate-term bond fund returned 1.1 percent during the first quarter. While that’s off from earlier years, when 2-percent quarterly returns would sometimes occur, it’s also far from the big losses that some investors were anticipating.