LONDON -- The volatility that returned to financial markets in the first quarter of 2007 is likely to remain a feature for the rest of the year as investors grapple with an uncertain outlook for global growth and interest rates, analysts said on Tuesday.

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Most major global stock markets rose in the first three months of the year, the third successive quarter of gains, while commodities generally firmed and bonds were mixed.

But betting that the record low volatility seen at the start of the year could not last was the best strategy in the first quarter.

A combination of concerns including growing problems in the U.S. subprime mortgage lending market, a sharp sell-off in Chinese stocks and rising tensions between Iran and the West prompted investors to reduced their risk exposure.

That resulted in big spikes in equity and currency volatility measures before markets regained some of their composure by the end of the period.

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The Chicago Board Options Exchange Volatility Index ended the quarter more than 26 percent higher, while one-month dollar/yen volatility was up more than 40 percent.

"I think volatility will be higher going forward," said Frances Hudson, an investment director at Standard Life Investments.

"We're still fairly constructive on equities but we have reduced our bets in the more volatile equity asset classes and gone for more defensive, yield-backed ones," she said, preferring markets in the U.S., UK and Europe over emerging markets.

Fund flow data from Emerging Portfolio Fund Research (EPFR) shows a similar strategy from other institutional investors.

There was a sharp decline in appetite for emerging market assets versus developed equity markets in the first quarter compared with a year earlier, which weighed on total equity inflows, EPFR said.

STOCKS GAIN, BONDS MIXED

Still, emerging market stocks performed relatively well over the quarter, with MSCI's global emerging markets index up 1.8 percent, barely below the 2 percent gain in the All-Country World Index.

Europe registered a solid 2.2 percent, boosted by a near 5 percent rise in Germany's benchmark index.

Wall Street underperformed with the Dow Jones industrial average down almost 1 percent and the Standard & Poor's 500 up just a fraction of a percent.

Asian markets were mixed, with China's Shanghai Composite index up 19 percent for the quarter despite a near 10 percent one-day fall in late February, while Bombay's Sensex was down more than 5 percent. Japan's Nikkei 225 rose 0.4 percent but the broader TOPIX added 1.9 percent.

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"The key, when we get back after Easter, will be how the results season in the States goes," said Michael O'Sullivan, a strategist at State Street.

"If we get lots of profit warnings it'll be interesting to see if volatility (returns) because, generally, economic indicators there have been slowing."

Among government bonds, U.S. Treasuries outperformed other fixed income assets, particularly in Europe, as markets began to price in the chance of the Federal Reserve cutting interest rates later this year.

Interest rates elsewhere are largely still seen rising but there is ample debate about how long the rest of the world can continue to ignore the slowdown in the United States.

Gold enjoyed another solid quarter, rising more than 4 percent, while geopolitical tensions spurred a 7.9 percent gain in U.S. light crude oil prices after losses in the previous two quarters.

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