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Eastern European party may not be over

While 30-per-cent-plus annual returns might be a thing of the past, many fund managers still like prospects in emerging Europe

FUNDS REPORTER

TORONTO -- When it comes to investing globally, Eastern European markets have been among the hottest regions in recent years.

Despite average annual returns of nearly 32 per cent over five years to the end of 2007 [MSCI Emerging Europe Index in euro dollars], some fund managers contend that the party is not over.

While the region is still down nearly 13 per cent this year, and participated in last week's global market selloff, they say that volatility is just part of investing in fast-growing, riskier economies.

"We have seen drops in the markets of something like 20 per cent anyways - even during a bull run," said Ghadir Abu Lei-Cooper, who heads an emerging European equities team at London-based Baring Asset Management Inc. "For emerging markets, it's not such a strange occurrence."

The investment case "still stacks up in emerging Europe," argued Mrs. Abu Lei-Cooper, who was in Toronto recently to promote the new Excel Emerging Europe Fund in Canada.

"We are going to see a slowdown in the U.S. economy," she said. "That is now what the markets are pricing in globally, but we believe that emerging markets and emerging economies are going to compensate somewhat because they are urbanizing and industrializing. They are not just making things to [sell] to the United States."

Emerging Europe ranges from countries such as Russia and Turkey to those like Poland, Hungary and the Czech Republic that have joined the European Union (EU) in recent years.

"The region is still early in its development phase," said Fehim Sever, a London-based manager for Fidelity Investments Canada Ltd.

"If you take a three-to-five-year view, the earnings prospects in that region are looking very attractive," said Mr. Sever, whose Fidelity Europe Fund is 50 per cent directly or indirectly a play on emerging Europe.

Russia is a top country holding for many managers. Economic growth in Russia is expected to be in the 6- to 7-per-cent range this year, and "we think the economy is firing on all cylinders," said Mrs. Abu Lei-Cooper, who has 60 per cent of her fund in Russian stocks such as gas monopoly Gazprom and bank giant Sberbank.

Russia will benefit from external demand for commodities like oil and gas, she said, adding that investing there is also a way to play the Chinese and Indian growth story with their hunger for resources. And growth will also be fuelled in Russia by rising infrastructure spending, she added.

Central European countries like Czech Republic, Poland and Hungary are part of the continuing "convergence story" with Western Europe, and these countries will benefit from substantial European Union investment funds to bring its infrastructure to Western standards, she said.

Emerging European countries are also getting an injection of corporate investments from Western European manufacturers, Mr. Sever said.

"They want to move manufacturing east because [labour] costs are cheaper, productivity is higher and infrastructure is getting better."

Mr. Sever is also bullish on southeastern Europe, including countries such as Greece and Turkey, because some companies are benefiting from a growing middle class.

Fourlis, the Greek franchisee of Swedish furniture chain IKEA, is a major holding in his fund. "It has the IKEA franchise in Greece, Bulgaria and potentially other Balkan countries over time," he said. "It is a direct play on consumer expenditure in the region, which is still at a very low level versus Western European levels."

Mark Mobius, manager of the Templeton Emerging Markets Fund at Franklin Templeton Investments Corp., is also upbeat on Eastern Europe because "growth is continuing at a pretty good pace."

He has investments in oil giant Lukoil and Gazprom in Russia, but he particularly likes Turkey because of its growth prospects and falling interest rate environment. "We are mainly in the banks, some of the oil field companies and telecoms [in Turkey]," he said.

Investing in emerging European markets is not without risks, managers say. Countries that have joined the EU are seen as less risky than those like Russia, Turkey and Ukraine that are still outside this community. Turkey has been aggressively lobbying to get into the EU club.

Still, Mrs. Abu Lei-Cooper is not concerned about the political risk in Russia where president Vladimir Putin has anointed First Deputy Prime Minister Dmitry Medvedev as his successor in the March 2 presidential election. He is someone who "the market likes" because of his pro-market views, she added.

Mr. Mobius sees the recent downturn as a "normal short-term bear market" that will be followed by a bull market.

The party is not over, but investors should not expect the 30-per-cent-plus returns every year, he said. "I am not going to say that it is not going to happen, but I am saying that it would be a mistake to expect it year after year."

Real GDP growth in 2007

Sample of real GDP growth in 2007 in emerging Europe*

Emerging Europe
Slovakia8.5%
Estonia7.9%
Russia7.2%
Ukraine6.8%
Poland6.5%
Romania5.8%
Croatia5.7%
Czech Republic5.7%
Turkey5.2%
Austria3.1%
Hungary2.1%
North America
Canada2.2%
United States1.8%

* Real GDP is gross domestic product adjusted for inflation.

SOURCE: THE ECONOMIST

© 2007 The Globe and Mail. All rights reserved.

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