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New Europe comes in from the cold

This month marks the expansion of the European Union to create the world&#39s biggest single market. The inclusion of New Europe will see the EU grow from 15 to 25 members.

Poland, Hungary and the Czech Republic, which together represent more than 80 per cent of GDP in the region, are likely be the primary targets for investors. Also joining the alliance will be Cyprus, Estonia, Latvia, Lithuania, Malta, Slovakia and Slovenia.

UK investment houses are gearing themselves up for the change in dynamic.

Credit Suisse Asset Management&#39s range of specialist funds includes its European frontiers fund run by Neil Gregson. Since launch in May 2001, the fund has outperformed the average emerging markets fund by 53 per cent.

Credit Suisse head of emerging European equities Elizabeth Eaton says the group is particularly interested in the region&#39s underdeveloped banking sector, which offers several opportunities for equity investment. She says regional banks are growing retail loans and producing returns on equity as high as 25 per cent.

Jupiter offers one of the only other specialist Eastern European funds while Baring Asset Management has an Eastern European investment trust. However, most IFAs say they would recommend global emerging markets funds such as those from Franklin Templeton or First State for investors looking for exposure to Eastern European markets.

Chase de Vere Financial Solutions savings and investment manager Anna Bowes believes it will be a long time before mainstream European funds include the new EU countries in their offerings.

She says: “Does joining the EU make these countries any more stable than before? I would say no. They still have a long way to go.”

To join the single currency, each of the new EU members will have to meet a series of tough economic targets. Some analysts predict strong growth from the new members as they work towards meeting the Maastricht criteria but others believe it could take Poland, Hungary and the Czech Republic more than 10 years to meet their targets.

Similarly, while some analysts believe the requirements will ensure that countries work hard towards ensuring stability, others believe rapid growth could see inflation rise and interest rates fluctuate.

Even the biggest EU countries are struggling to keep fiscal deficits in line, notably Germany, which is facing a penalty for missing its deficit target for the fourth year.

Bowes says she expects only a few more sophisticated investors to specialise in Eastern European investment. However, she suggests that many fund managers will target UK-listed companies that invest in countries such as Poland and Hungary.

Foreign investment in New Europe is thriving. European car manufacturers such as Peugeot and Seat are opening plants in Hungary and Poland, looking to benefit from lower labour costs and corporate taxes than in Western Europe.

Aberdeen Asset Managers head of emerging markets Joanne Irvine says the group believes the coming year will see higher levels of volatility as investors gauge the success or failure of the monetary and fiscal policies implemented by the governments of Hungary, Poland and the Czech Republic.

Irvine says foreign fund flows will be specific to individual economies rather than the overall region. As a result, Aberdeen will view any weakness in large-cap stocks as a buying opportunity.

But Hargreaves Lansdown senior analyst Meera Patel is more sceptical. She believes investors should be more cautious and avoid jumping on the New Europe bandwagon too hastily. She says investors need to bear in mind that most existing funds offer a fairly similar risk profile to emerging markets funds and are not for the fainthearted.

“At the corporate level, there is a fantastic case for investing across the board but how fast these countries grow will depend on the process of growth. It is certainly not going to be plain sailing,” she says.

Patel believes the changes in Europe look more like divergence than convergence and thinks commentators are getting a little overexcited at the prospect of capitalising on growth quickly.

Chelsea Financial Services managing director Darius McDermott believes the opportunity to see big returns may have already passed. He feels that the growth seen in countries such Hungary in the run-up to joining the EU has to a certain extent peaked.

He says: “I would pose the question: &#39Have we missed the boat?&#39 But I think there are exciting investment and asset allocation opportunities within Hungary and Poland.”

McDermott favours products such as the Gartmore European fund run by Roger Guy, which offers selected opportunities in Eastern Europe, or Artemis&#39 European fund.

Best Invest fund research analyst James Calder tips Jupiter&#39s specialist fund.

Analysts believe the trade links each of the bordering countries have with Russia are another strength that will generate growth. McDermott says investors buying into Russia are essentially placing most of their money in commodities such as gas and oil and believes Eastern European countries could be a more lucrative alternative.

JPMF has four funds with some exposure to Eastern Europe with £624m under management. Its emerging Europe equity fund has 33 per cent of its assets invested in EU convergence markets, as well as 44 per cent in Russia and 21 per cent in Turkey. The fund had £193m under management at end of March.

McDermott tips Turkey as the next possible favourite for investors looking at emerging markets. But Turkey is yet to join the EU and its complex political situation following Cyprus&#39s no-vote in the UN reunitisation referendum makes it a tricky area to forecast.

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