Mutual fund investors were an optimistic bunch in the fourth quarter. They clung to hopes of a U.S. economic recovery, even after enduring lots of bumps and two major shocks that left the S&P 500 up just 5.8% for the quarter, a shadow of the strong 10.8% from the same period a year earlier.

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The strong performers turned in double-digit gains - real estate, for instance, was up 14.8%; industrials advanced 14.2% and energy gained 14%. This group of market leaders demonstrated that investors started to regain confidence in equity investing - so long as the funds offered income and diversification.

"Investors have been putting their money back to work in specific areas," says Tom Roseen, a senior analyst at Lipper. The equity income fund group was up 11.7%. This subset of the U.S. diversified equity group includes giants like Johnson & Johnson that are big dividend payers. Such strong confidence in domestic equity funds meant certain global equity funds lagged. India-region funds were down 16%. Investors also backed off their enthusiasm for precious metals, sending that sector down 5.7%. Funds holding shares of gold mining firms were down 20.9%.

"The miners are not necessarily getting bullion," Roseen says. "They have their own expenses and forecasts. Miners did poorly because ... investors might not see a rebound in gold."



Fixed-income funds, particularly government bonds, which had posted the strongest performance numbers in the third quarter of 2011, also took a backseat to equity funds. Yet the group managed to turn out solid performances.

Pimco Total Return, which made headlines for shunning Treasuries in February, only to miss the yearlong Treasury rally, was up 2.2%. That's not bad, Roseen says, adding that the fund managed not to underperform the fixed-income average. Municipals, which stole the show in the third quarter, ended the fourth quarter up 1.9% For the year, the category gained 9.2%.

"That is in stark contrast to what Meredith Whitney had been predicting," says Russ Kinnel, director of mutual fund research at Morningstar, alluding to the analyst's conviction that the municipal bond market was headed for massive defaults. "We had a drop in defaults, but Whitney's predictions scared off investors, and they were redeeming muni funds early in the year.

They missed out on great returns."



Fixed-income funds also posted reasonable net inflows, about $16 billion. That represented about 3.5% of existing assets. Treasury funds, continuing their yearlong run, collected $11.5 billion in net new assets, accounting for the lion's share of inflows. "What we're seeing is that a lot of investors in mutual funds and the fixed-income side are gearing up and trying to prepare for the Fed's rebalancing," observes Leon Mirochnik, a research analyst at TrimTabs, referring to the Federal Reserve's maturity extension program through June 2012.

Municipal bond funds had very modest inflows for the quarter, roughly 1% of their assets, Mirochnik says. That amounted to about $860 million in funds.

"They are not seeing a lot of inflows, and I would say in the first part of 2012, they are not going to," Mirochnik says. "It is going to be modest."

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