Hong Kong funds have held their position in the top five best-performing sectors during the five months to the end of May, according to the Hong Kong Investment Funds Association (HKIFA). Over 12 months, Japanese warrant funds took the top spot with returns of more than 75 per cent. However, in the past five months returns in the volatile sector plunged to about 2 per cent. North American funds also continued their extended bull run with 12-month gains of 34 per cent. Natural resource funds took third place with a return of 31 per cent, and Australian funds were in fourth spot with a return of 26 per cent. Hong Kong funds slotted in at number five position with average returns of just over 22 per cent for the 12 months and 13 per cent for the year to date. Andrew Lo, chairman of the HKIFA, said: 'The relatively satisfactory return is probably due to the recovery in the property market and the lowering in interest rates by China, which shows signs of a 'soft landing'.' The next best-performing Asian sector was Indonesia which had an annual return of about 14 per cent. Bond funds and only one market fund sector pushed through into the top performers. Australian money funds, buoyed by the prospect of a tight monetary policy and government pledges to slash the deficit, posted gains of 18 per cent. Mr Lo nominated low interest rates and corporate restructuring as the reasons equities outperformed other sectors. For investors in the Hong Kong market, Cheah Cheng Hye, a fund manager at Fund Managers, believes smaller-cap stocks will offer the best returns, but with more than 500 second-liners to choose from investors need to be cautious. Mr Cheah said: 'The gap between second-liners and the blue chips is still too wide.' Investors are still able to buy good second-liners at half the price-earnings multiples of the blue-chip. 'A momentum has also been established. Smaller caps this year are up by 18 per cent while the blue chips have gained just 10 per cent.' Mr Cheah also believed that smaller caps were less likely to be hit by nervousness about interest rate increases - the Hang Seng Index is dominated by property, banking and utilities stocks. Mr Cheah is bullish about V-Tech Holdings, Hong Kong's biggest consumer electronics firm, and Gold Peak, the electronics group.