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Eastern promise

When investors are confronted with the idea of emerging Europe as an investment theme, the idea that probably springs to mind is risk. But risk is relative and can be turned around as opportunity. Arguably, there is more risk involved in investing in a developed market company at a high valuation compared with an emerging market company on a low valuation.

This was evidenced in the early part of this decade when being invested in some emerging markets could give relative safety. Investors should prefer the risk/reward characteristics of an emerging market where most of the concerns are out in the open and potential returns greater against the risk of shenanigans in a developed market where risks may be less visible and returns sub-optimal.

So where should investors position a portfolio after a four-year bull run in global equity markets. There is a consensus that when markets do turn down, the aftermath will be unpleasant.

As always, history provides clues to where there should be protection against market falls or where positive returns can be generated. From 2000 through to 2003, there was a region that was unaffected by the global recession and market falls. The very fact that it was an emerging market ensured that the opportunity was exploited by relatively few investors.

In retrospect, it appeared all rather obvious.

The region in question emerging Europe comprises Russia and its former Eastern European satellites. We would consider Russia to be less of a converging Europe theme and more of an internal reconstruction story, so excluding it from this analysis.

The unwinding of the Soviet bloc started many years before but the catalyst for change was the eastward expansion of the EU. What many missed was the fact that the EU was eager to expand its boundaries. With Western European countries such as Norway and Switzerland unwilling to join, the obvious candidates were in the East.

In 2001, the EU announced that 10 countries would be considered for entry in 2004, the major ones being Hungary, Poland, the Czech Republic and the newly formed Baltic states. Unsurprisingly, they were the countries closest to Western Europe.

Their respective stockmarkets, if they existed at all, were in their infancy. Listed companies represented old Soviet-style companies, lacking in entrepreneurial spirit and starved of capital.

Valuations were very low but their potential was high. This attracted interest not only from Western banks which identified restructuring opportunities but from Western companies. There was a raft of new issues and cross-border transactions which created and released substantial value. However, as global markets recovered in 2003, the restructuring and revaluation of these markets took a back seat as it is been easier to generate returns from pure general market exposure.

Today, the opportunity continues to exist. The EU is continuing its expansion eastward, with the second wave of entrants Romania and Bulgaria being admitted in 2007.

It is relatively simple to see where the next opportunities are going to be. Head east to the Ukraine, Croatia, Macedonia and even Turkey in fact, many of the countries much berated in the recent Eurovision Song Contest. These countries are willing Europeans embracing the newly discovered freedom of capitalism.

This compares with the complaining, cynical, backbiting versions seen in the UK, France and Germany. What is happening is history repeating itself companies being refinanced, capital and expertise imported, cross-border acquisitions being made and valuations increasing.

It is easier to spot the candidates this time round, however, so the returns are less but they are still there. Where would you rather invest? Thought so.

Donald Robertson is joint fund manager of the SVM Asset Management global opportunities fund.


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