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Eastern promise

Matt Goodburn says fund firms are sticking with Eastern Europe and particularly Russia as they believe in the fundamentals despite recent downturns

Emerging Europe has suffered in recent months, with the region’s markets being hit particularly hard by the global stock- market correction.

This is not unexpected, with emerging markets typically suffering a liquidity drain in times of uncertainty as investors look to reduce their exposure to risk but it does hammer home the fact that the emerging Europe growth story is not a one-way bet.

The Turkish lira fell by over 20 per cent against the euro in May while the Russian stockmarket fell by 25 per cent in 10 days.

But this is not deterring some fund managers. Merrill Lynch emerging Europe fund co-manager Alain Burrier believes that over the medium to longer term, Eastern European markets will offer better returns than the more mature markets on the Continent.

He says: “Russia and its former Soviet republics are becoming safer investments. There was always a question mark about just how stable these places were. Now they are much more accepted as places to invest. At the same time, Central Europe is becoming much more mature and that means slowing growth.”

Credit Suisse co-head of multi-manager Garry Potter says the region offers potentially more attractive returns than mature Europe and notes that the growth of the region in terms of its weighting in the global index will make it increasingly difficult to ignore.

He says: “Right now, the UK represents around 10 per cent of the world’s markets but Europe represents about 34 per cent. The UK is a mature economy and stockmarket so one could conclude in the context of European monetary expansion that the euro will outstrip European equity growth because of countries such as Turkey knocking on the door.

“The new European economies are generally growing at a faster rate than the older ones. There is a risk that they will create a threat to the older economies, particularly with cheap labour.”

If in the longer term, the picture appears rosy, how about the shorter term? The Russian stockmarket suffered its worst slump since its crash in 1998 after the Government defaulted on a bond payment, causing widespread panic and massive capital flight from the country.

Jupiter emerging European opportunities fund manager Elena Shafton says the fall has to be put into context. Net inflows into the region during the first quarter reached $2.5bn, equivalent to 48 per cent of the total inflows in 2005. As global concerns about higher inflation and interest rates led to a growth in risk aversion, Russia was a natural choice for profit-takers because the market had rocketed by 200 per cent in the previous 18 months.

Shafton says the underlying fundamentals are now much stronger than in 1998. She points to Russia’s significant current account and budget surpluses, foreign exchange reserves of $250bn, the high oil price of $70 a barrel and bond yields in line with developed economies.

She says: “Despite these supporting factors, the equity market trades on a very low valuation. The main risk to the Russian economy is a prolonged slump in the oil price, say, to below $30 a barrel. This, we believe, is highly unlikely due to unrelenting demand and geopolitical tensions that continue to threaten supply.

“As a consequence, Russia is enjoying huge inflows from exports, which should support economic growth and equity valuations for the remainder of this year and beyond.”

Bestinvest communications director Justin Modray believes that investors should be wary of emerging markets funds’ reliance on Russia and in particular the oil and gas sector which dominates the Russian economy.

He says: “The Barings emerging Europe fund and the Jupiter emerging European opportunities funds both have over 50 per cent exposure to Russia, which has an overwhelming bias to the oil and gas sector.

“This is something that investors should be aware of but I believe the long-term prospects for the region are favourable.”

Shafton is also bullish about the wider region, saying that many of the positives underpinning her conviction about Russia are also present in the neighbouring Eastern bloc countries.

She says: “This strong macro picture is not only the case with Russia but many other countries in the region bar a few exceptions.

“Now that the speculative froth has been blown off, equities will resume their upward trend, albeit at a more modest pace than earlier in the year.

“Indeed, we have used the correction as an opportunity to add to selected holdings in the portfolio, particularly in the oil and commodities sectors, where valuations still appear attractive.”

For investors put off by the volatility and corporate governance issues still surrounding Eastern Europe, many mainstream European equity fund managers say there are still pockets of attractive growth in the eurozone.

M&G pan-European fund manager Giles Worthington says: “Ireland and Greece in particular are enjoying growth rates comparable with the emerging economies of Eastern Europe. Greece is a euro-denominated emerged market that is experiencing 3-4 per cent GDP growth and strong construction, tourism and banking markets.

“Similarly, Ireland is enjoying an economic boom, with GDP growth of 4.7 per cent in 2005, a rate very comparable with or greater than many Eastern European economies, driven by a growing population and high rates of inward investment.”

Seven Investment Management business director Justin Urquhart Stewart says the abundant levels of private equity raised for European projects, particularly by group such as Cinven and Permira, point to continued solid growth prospects for the region as a whole.

Urquhart Stewart says: “There is no shortage of funds for M&A activity. The prospect of no let-up in restructuring activity coupled with the attractive level of equity valuations will hearten investors.”

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