Asian equity funds performed well in the second quarter in a "rally driven by junk", but a correction may be on the cards for the autumn, according to the fund services divison of rating agency Standard & Poor's.

The median Pacific fund returned 27.4% in the quarter and its Southeast Asia counterpart returned 31.6%, according to a S&P Fund Services survey released yesterday. Investors in Southeast Asian smaller companies fared even better, with the median small-cap fund returning 48.8%.

However, funds focused on high-quality stocks had a tougher time. Following outperformance in 2008, AAA-rated CG Nouvelle Asie and AA-rated AXA Rosenberg Pacific Ex-Japan Small Cap Alpha Fund fell to the bottom quartile of the S&P Southeast Asia mainstream sector and the smaller companies sector, respectively.

Kevin Chen, chief investment officer at AXA Rosenberg in Singapore, says the second-quarter rally was particularly challenging for the group's investment process. The ability to forecast a company's earnings correctly was almost irrelevant, as markets rewarded those stocks and sectors where earnings expectations were lowest. The best-performing stocks over much of the quarter were the relatively cheap, higher-beta stocks that had been most beaten down previously.

Meanwhile, due to Comgest's emphasis on finding high-quality, undervalued growth opportunities, the strong cyclical rally in China hurt returns, says Vincent Strauss, manager of CG Nouvelle Asie.

Two other poor performers in the second quarter were A-rated Allianz RCM Asia Pacific Fund and AA-rated Allianz RCM Oriental Income, the former ranking in the bottom quartile of the S&P Southeast Asia equities sector and the latter in the bottom quartile of the S&P Pacific Mainstream sector. Portfolio analyst Joshua Smith attributes the underperformance to the team's adherence to its "growth, quality, valuation" focus in the stock-picking process. This meant that the portfolios were not positioned for a 'V'-shaped asset rally in which small caps and low-quality names led the way.

In terms of countries, the best second-quarter performer was Indonesia (S&P BMI Indonesia returned 67.6%). Stocks there were boosted by healthy domestic demand following a continued decline in interest rates and by the likelihood of the incumbent government's re-election in July to promote pro-growth policies. India (+61.1%) and Thailand (+50.7%) also performed well. The laggards were the export-dependent markets of Japan (+23.5%), Korea (+26.7%) and Taiwan (+27.4%).

However, while managers believe the strong fundamentals supporting Asian markets remain intact, they expect regional markets to remain volatile. Given the fragility of the global economy, a market correction seems likely, says Nick Scott, CIO for Asian equities at BlackRock. The extent and pace of the market rebound since March has been "astonishing" and a correction over the autumn seems likely, agree Angus Tulloch and Alistair Thompson, in charge of the AAA-rated First State Investments - Asia Pacific Leaders Fund.

For the best-performing funds, consumer plays -- particularly in China and Hong Kong -- were strong contributors. The Templeton Asian Growth Fund, managed by Allan Lam, benefited from both consumer and commodity stocks, particularly metals and mining names. The fund posted a top-decile performance in the S&P Southeast Asian equities sector over both three and six months to the end of June.

And consumer equities, such as high-end retailer Ports Design and lottery company REXLot Holdings, helped the BlackRock Global Funds Asian Dragon Fund to a top-quartile ranking, says BlackRock's Scott.