The second quarter of 2009was a record-breaker for mutual funds. The average mutual fund was up 20%, and the $40 billion that poured into equity funds made it their best quarter since the first three months of 2007.

BETTER BONDS

But bonds had an even bigger story. Investors put $90 billion into bonds in the second quarter, adding up to an astonishing $154 billion for the first half of the year. Flows came from just about everywhere-the sidelines, equities, Treasuries and money markets.

"We've never seen anything like this," says Vince Deluard, global equity strategist at TrimTabs. "The money is flowing out of money market funds into bonds because investors don't feel confident enough about equities yet and money markets have no yield. Short-term rates are at 1% or so, so there's no point in having any money there right now." Bond funds were up 5% on average last quarter, which Deluard attributes to the Fed's rate cuts and the narrowing of spreads-both of which cause prices to rise.

High-yield bonds accounted for 14 of the 20 best-performing fixed-income funds. The Fidelity Advisor High Income Advantage Fund, for example, was up 34.5%. But their rally may not last much longer. "There's a floor for the price," Deluard notes. "They can't retrade above 100, so when rates are close to zero and spreads narrow, which is the case, there's very little upside left. I'd be very surprised if they get these kinds of returns much longer."

LOOKING OUTSIDE THE BOX

The best performer of the quarter was emerging markets, particularly China (up 80% for the year) and Brazil (up 70%). In fact, eight of the 20 top-performing funds were either Asian or Latin American funds, while foreign mutual funds accounted for 19 of the 20 overall. "Things got smashed last year and people fled emerging markets because they're typically deemed riskier, and people fled any and all risk," says John Coumarianos, a mutual fund analyst at Morningstar. "This year, people took a look at the prices and said 'maybe they're looking cheaper.'"

The real estate market, which came roaring off its bottom in the U.S., also shot up in the far-better-off Asian market. The Alpine International Real Estate Fund, a global product, was up a whopping 63.76%, for example. Meanwhile, the domestic real estate market, despite an impressive quarter, is still fraught with problems.

"American real estate companies are leveraged up to their eyeballs and they can't afford to pay their dividends in some cases," Coumarianos says. "Asian real estate companies aren't as badly leveraged as their European and American counterparts; they went through their credit mess a decade ago."

SELLING OUT

Treasuries, the standout sector of 2008's meltdown, saw lackluster returns in the second quarter. The haven funds had reached prices that meant they weren't giving investors much yield to own them, Coumarianos notes, pushing prices and demand down. And people began selling.

So what does this extraordinary quarter mean for mutual funds and, more importantly, for the U.S. economy? Well, maybe not much. "If you look carefully at what companies are doing, they're selling a whole lot of shares," Deluard explains. "In May, $77 billion was sold in company shares. And when companies are selling, it's a bad sign. We're also not seeing insider buying and corporate buyers haven't taken part in this rally. The U.S. economy simply is not improving at all."