When conditions are bad, sometimes it's best to stay home. That's largely how mutual fund investors felt about the second quarter. The news around the world did little to instill confidence, from Greece's debt crisis to Spain's banking troubles to China's growth slowdown. Funds that invested overseas were among the worst performers. They did better in the U.S., but bonds were the place where investors sought solace.

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"It was a bad quarter for riskier assets," says Jeremy DeGroot, chief investment officer with Litman Gregory Asset Management. "The place to be was the safety of Treasury bonds."

Performance took a turn for the better in the last days of the quarter after a summit meeting of European leaders unexpectedly produced a variety of measures to address the eurozone's debt and banking crisis, leading European shares higher.

 

SHINING SECTORS

A few sectors managed to break out of the doldrums: real estate, utilities and health care. Low yields pushed more investors into areas where they had a better chance of finding some income. In real estate, "a lot of investors feel like there's some opportunity there and yields are attractive," says Matthew Lemieux, a research analyst with Lipper. "Many think we've hit a bottom in the housing market."

But because of real estate's strong rebound this year, some investors believe it's time to look elsewhere. "Real estate is a stay-away category for us because of the valuations," says Lou Stanasolovich, CEO of Legend Financial Advisors.

Utilities, on the other hand, are seen largely as a defensive play for buyers who may still want some equity exposure but want to hedge their bets.

Health care, meanwhile, made a late-quarter sprint after the Supreme Court's decision to uphold the landmark health care law. The court's decision finally gave the sector clarity, Stanasolovich says. Hospital stocks rallied because fewer uninsured people will make emergency rooms their first stop for treatment. But insurers fell because their costs might rise with the law's requirement that they spend a certain portion of the premiums they collect on medical treatments. Over the long term, Stanasolovich believes health care stocks will do well. "It's a sector that is growing, but is not growing by leaps and bounds," he says.

 

BONDS GET A 'TWIST'

Not surprising, investors again dived headlong into bonds, despite clarion calls for caution at a time of historically low interest rates. "For better or worse, people still view U.S. Treasuries as the risk-free asset," DeGroot says. "But the math isn't there."

The Federal Reserve's decision to prolong its Operation Twist by buying long-dated Treasuries with the proceeds of sales of short-duration paper served to push down yields - and drive up prices - on the long end. Zero-coupon bonds also did well as a result.

But long and zero-coupon bonds are seen as the most interest-rate sensitive instruments around. Among the worst performing fixed-income sectors were high-yield and emerging-market bonds, categories where investors perceive higher risk.

"Corporates are just not outperforming," Lemieux says. "Investors are holding them, but there's nothing that's really rallying them."

 

 

Ilana Polyak, a Financial Planning contributing writer, has also written for The New York Times, Money and Kiplinger's.