#6 - JRL 7244
Sunday Telegraph (UK)
June 29, 2003
Full of eastern promise
The economies of the former Soviet bloc are growing fast, but restrict your investment to a sensible level
By Paul Farrow
When President Vladimir Putin last week became the first Russian leader in 129 years to pay a state visit to Britain, several fund managers took the opportunity to crank up the Eastern European investment story.
They point out that the region's stock markets, which include Poland, Russia and Hungary, have outperformed the major western stock market indices by more than 20 per cent in the past year. The MSCI East Europe Index grew by 14.9 per cent, while the FTSE All-Share fell 6.4 per cent and the S&P500 by 7.7 per cent.
The question now is whether there is more to come from Eastern Europe, or whether the recent bounce is as good as it's likely to get for the time being.
Plamen Monovski, a Bulgarian who runs the Merrill Lynch Investment Managers Emerging Europe fund, certainly thinks there is plenty of opportunity for further gains. In fact, he says: "There has been no better time to buy. Eastern Europe currently has the fastest-growing stock markets in an otherwise stagnant world."
Monovski reckons that forthcoming European Union membership for a number of central European countries is a huge positive for the region. Ten countries, mainly from the former Soviet bloc, are due to join the EU in May 2004. In the past, countries such as Ireland, Spain and Portugal have experienced strong economic growth in the run-up to and aftermath of EU membership.
In the past four years, three of the 2004 recruits - the Czech Republic, Hungary and Poland - have outpaced existing euro zone countries in terms of gross domestic product growth. Real wages are on the increase and consumers are starting to borrow. Mortgages, for instance, were non-existent in Hungary a few years ago, yet they are now increasing at a rate of 150 per cent a year.
Labour costs are also substantially lower in central Europe, averaging 5 an hour compared with 24 in the EU, while educational standards are comparable. Many global companies now outsource to the region; Audi and Microsoft, for example, both have big operations in Hungary.
"The convergence story is very positive," says Monovski. "The poorer countries need to come into line with the richer member countries in terms of road networks, information technology systems, hospitals etc - and they will benefit from EU investment worth around 100bn [ pounds 71bn]."
But EU wannabes will not find it all plain sailing. Although several countries are joining the EU in 2004, they are still a long way off joining the single currency. "Convergence isn't a simple one-way process," says John-Paul Smith of Pictet Asset Management. "There are large budget deficits and plenty of economic problems ahead."
UK investors wishing to tap into the emerging European markets have the choice of just half a dozen or so unit trusts and investment trusts, the latest being Jupiter's Emerging Europe unit trust, launched last September. Unlike other Jupiter funds, this is not aimed at the mass consumer market, but at sophisticated investors only. The fund has grown by 28 per cent since launch.
"It was the perfect time to launch," says Elena Shaftan, the fund manager. "The markets were undervalued and growth opportunities in other areas were hard to find. That's why the fund has done well."
Russian-born Shaftan, who has also lived in Latvia, reckons the market is likely to pause and trade in a narrow range for a while. But she still believes the long-term story is still very positive.
The central European markets are still undervalued, economic growth is coming through and the convergence rally is on the cards, she says. In Russia, Putin has brought stability which has attracted foreign and domestic investment.
Many experts reckon that Russia is an attractive long-term bet. Russians have money in their pockets, they say, most own their own houses, income tax is only 13 per cent and utility bills are very low. Western business is also making its mark. Branches of Ikea, the Swedish furniture chain, are springing up all over Russia, with four in Moscow alone.
According to Monovski, the average Muscovite spends $700 to $800 ( pounds 420 to pounds 480) a month - about the same as the average Swede. Russian companies used to be accused of poor corporate governance and many were dismissed as corrupt. But, says the bullish Monovski, this image is now changing.
"Yukos, one of Russia's biggest oil producers, brought in new management a couple of years ago that has turned the company around," says Monovski. "Today we get quarterly reports and transparency."
Yukos has emerged as a global giant after recently merging with a rival company. It is now the fourth-biggest listed oil company in the world, he says.
"Doing a Yukos" is now a common term, says Shaftan. "There has been a sea change in the way companies operate. They're beginning to appoint independent board directors, bring in western financial expertise and behave more openly. It's now a case of 'you ask, they respond'."
Not everyone agrees with this positive view. Mark Mobius, the highly respected manager of the Templeton emerging market fund, reckons that Russian companies on the whole are failing to get their acts together. Mobius has taken profits and reduced his weighting in Russia because he thinks that equities have become too expensive there.
"The shortage of stock and corporate governance remain big issues for us in Russia," he says. "Other than the big oil and telecom stocks, there's little to buy. Liquidity can also be a problem."
It has been difficult enough for investment professionals to sell the merits of mainstream equities to investors in the past three years, let alone funds invested in emerging markets. These are still high-risk investments and should not represent more than 2 per cent of an investment portfolio, independent financial advisers say.
"Some people reckon that countries entering the EU will clean up on foreign investment and cheap labour," says Charles Ansdell, an independent financail adviser at Inter Alliance. "But there are still questions about the ability to compete on an even keel once they've joined the EU - and that could be damaging."
"When people start describing countries like Russia as 'stable', you have to worry a bit. There are opportunities, but there will still be volatility. These are high-risk investments."