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Municipal bond skeptics take note: The group had one of the best returns in the second quarter. The average long-term muni fund was up 3.78%. After dire predictions of widespread defaults, there were only 26 in the first half, down from 60 in the same period for 2010, according to various reports.

"Institutional investors still need this product," says Jeff Tjornehoj, a mutual fund analyst at Lipper. "So yields went down quite a bit as buyers scrambled to get whatever municipal debt they could get their hands on." Long bets on California munis were the best niche in the category, up 5.25%.

Money poured into municipal bond funds - the category took in $981 million in net assets during the quarter - underscoring investors' desire for relatively safe assets with respectable yields. Indeed, there were no double-digit performance numbers. Health care funds, up 7.08%, consumer staples, up 4.72%, and real estate, up 3.47%, took the top spots.

"There was growing concern about sluggishness in the U.S. economy," says Russell Kinnel, mutual fund research director at Morningstar. "No one was having blowout-good sales numbers."

Investors who bought into real estate mutual funds focused on REITs. Yet that sector's performance did not suggest newfound confidence in the housing market. "Part of why they have done so well is that the single-family [real estate] market is on its back," Kinnel says. "If people are not buying homes, that can be a good thing for the apartment market."

Poorer performers included energy, down 5.72%, natural resources, down 5.19%, and financials, off 3.97%, as investors reacted to a second quarter filled with negative financial news. Unemployment had dipped to about 8.8% in March, but grew to 9.1% by May. "We have not had another crisis, but we've come close," Kinnel says. "We've had a lot of bumps."

Returns on international funds were positive overall, but they did not inspire a lot of confidence among investors, Tjornehoj says. The category had a tough period. The sovereign debt crises in Europe, particularly in Greece, resurfaced. Yields on government bonds from a few of those countries, like Greece and Portugal, soared into double-digits in May. In June, international funds lost 2%, but quarterly returns increased about 0.5% to 1.5%, Tjornehoj says.


Emerging-markets funds took a dip, about 97 basis points, Tjornehoj says, as investors feared sluggishness in developed economies would punish up-and-comers. In some ways, it did. Commodity prices slid in the quarter. "A lot of these developing economies are highly dependent on resource extraction," Tjornehoj says. "As a consequence, it hit them in the pocketbook first." India region funds were down 2.6%, and China region funds dipped 2.2%.

Morningstar reported that long-term mutual fund flows turned negative in June for the first time since December 2010. The sector lost $4.5 billion in June following a solid month of inflows in May when the industry took in $22 billion. Stock funds were to blame for the heavy losses, dropping $18 billion, making June the worst monthly outflow for the asset class since the peak of the credit crisis in October 2008.

Tjornehoj predicts financial trouble in Europe will dictate how the second half pans out. He is convinced that the euro is headed for the rocks. "I don't think it will break up in the third quarter - maybe we're looking at a year out or something like that," he says. "I definitely have my eyes on that region."