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Will new EU stars shine brightly?

Ten countries are set to join the European Union next year. Although some are small or have underdeveloped economies, others, such as Poland, Hungary and the Czech Republic, are among the bigger Eastern European nations.

While their impending entry has been the subject of much political speculation, the economic issues surrounding their membership have been largely ignored. This is surprising as some Eastern European and emerging markets funds are currently performing and, in some instances, selling better than others in different sectors.

Traditionally, membership has also provided a passport to greater economic stability, mainly through boosts to trade.

But with investor appetite for risk at such a low ebb, interest in less-established and underdeveloped markets is slackening. For an IFA, recommending a fund with exposure to Poland or Hungary is difficult enough, let alone one covering the smaller Eastern European countries set to join the EU, including Slovakia, Estonia, Lithuania, Latvia and Slovenia. The other two nations poised for entry – Malta and Cyprus – also hardly instill confidence in investors.

Plan Invest joint managing director Mike Owen believes the case for investing in these countries will be improved by joining the EU but not to the extent that it will prompt IFAs to steer clients towards these areas.

Owen says: “It is not ever going to be a solid plank. Membership will give countries respectability in terms of their trading and investment cases but there is always going to be a big risk with investing in them.”

Owen believes the new entrants will have to establish greater credibility over time for them to be taken seriously as investment prospects.

Michael Philips proprietor Michael Both says: “I would suggest countries joining the EU would need at least 12 months to establish whether they are really viable to invest in. But then I would move clients towards a VCT if they wanted to take risks, anyway, because of the tax breaks and because you have much greater idea what is going on with a UK company.”

But this view is not shared by many fund managers. JP Morgan Fleming fund manager Mark Robinson believes GDP growth in Poland, Hungary and the Czech Republic will outstrip many Western European markets this year. He also considers Estonia to be good bet and has several specific investments there.

First State Investments believes there are many opportunities within the countries joining the EU but says the problem often lies with access rather than performance.

Senior analyst David Gate, who works with star emerging markets fund manager Angus Tulloch, says: “A lot of their capital markets are shallow and narrow. There are not that many ways of gaining exposure. The danger is that money flows in and overwhelms both the bond and equity markets, which can quickly become overheated. We are slightly concerned about this happening in Hungary.”

Gates says it can be difficult to find companies which are big enough to invest in, which is why the banking and telecoms sectors tend to overheat so rapidly. Nevertheless, he says the 10 countries&#39 entry to the EU may persuade First State to be more positive about their prospects, citing the economic boost that entry has had on Ireland, Portugal and Greece.

But some fund managers suggest that most of the impact of joining – particularly with regard to the bigger countries – has already been absorbed. Invesco Perpetual emerging countries fund manager David Manuel says: “Hungary and the Czech Republic&#39s proximity to the EU has been a key economic driver for some time and has been important in our investing in them. Everyone knew it would happen but it will still make a difference when it does in terms of cementing the positive trend.”

Manuel says Invesco has been less impressed by Poland, which has slid into huge fiscal deficit. He also virtually dismisses the other joining countries on the basis that most stocks are chronically illiquid and therefore better suited to the more specialist fund houses.

Even some bond managers are fairly downcast about the seven lesser lights, lamenting companies&#39 lack of real debt and low yields.

Two countries which are causing more optimism among many fund managers are Bulgaria and Romania. Although these are not due to enter the EU until 2007, investment companies are certain that firms within both countries will generate high returns.

They are also excited about opportunities in Turkey, which it is hoped will soon overcome the domestic problems plaguing its hopes of entering the EU after Bulgaria and Romania.

For the 10 countries poised to join the EU, entry should create a better environment in which their firms can operate but many of the fundamental problems remain. There is no doubt the entrants will benefit from their new status but few fund firms are likely to be knocking on their doors just yet.


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