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Pulled along by the U.S. recovery, the global economy is clearly on the mend. But so far, that hasn't helped markets in the West very much. Indeed, most funds that invest in Western Europe and the U.S. lost ground in the first quarter. There was far more money to be made in emerging markets--especially Southeast Asia. "It was a quarter for growth rather than value stocks," says Emery R. Brewer, an emerging-market investment analyst in Prague for Chicago-based Driehaus Capital Management Inc.
All the top 25 funds in BusinessWeek's quarterly Offshore Fund Scoreboard were focused on emerging markets, clocking gains of up to 30% from Jan. 1 to Apr. 1. Emerging-market funds also outperformed for the year ending Apr. 1, leaping ahead by up to 32%. It was the best time in years to invest in both Southeast Asia and Central and Eastern Europe. "Stocks in those regions benefited enormously from low global interest rates and renewed growth in the U.S. and the euro zone," says Mehran Nakhjavani, an executive director who oversees emerging-market strategy at UBS Global Asset Management. "Investors who bought those emerging markets found themselves in a very sweet spot."
Offshore funds, which are typically based in tax havens such as Luxembourg, aren't permitted to market to U.S. residents because the U.S. Securities & Exchange Commission doesn't regulate them and because they don't file reports with the SEC. But many U.S. institutional and retail investors pour money into them anyway. So do millions of other savers around the world. This means that offshore funds represent a huge market that reflects the collective judgment of fund managers and other investors worldwide. BusinessWeek's survey, drawing on data from Standard & Poor's Fund Services (which, like BusinessWeek, is a unit of The McGraw-Hill Companies), tracks the performance in dollar terms of the 500 biggest offshore funds. (A complete list is available at www.funds-sp.com.)
A fund focused on Thailand--the country where the Asian turmoil began in 1997--produced the highest return in the first quarter. Fidelity Investments' $250 million Thailand Fund jumped 29.26%. Keith Ferguson, Fidelity's chief investment officer for the Asia-Pacific region, says that's because a wave of corporate restructuring has piqued investor interest in the country. The U.S. recovery has given Thailand and other Asian economies--outside of Japan--a big boost, too. The region's export-driven manufacturers benefited almost immediately when U.S. consumption started to pick up in the final quarter of last year.
Asia funds may have led the pack--the top three funds concentrated on Southeast Asia--but Central and Eastern European funds weren't far behind. Just as Asia quickly profits from a U.S. upswing, Central and Eastern European exporters do well when Western Europe rebounds--and since the beginning of the year, Europe has been doing just that. "There are a lot of early cyclical stocks, such as energy and raw-material producers, listed in this region," notes Richard Schmidt, a portfolio manager at J.P. Morgan Fleming Asset Management, whose JPMF Eastern Europe Equities A-Euro fund gained 15.55% in the first quarter. "With Europe on the path to recovery, those companies have been forecasting stronger earnings and have seen a big pickup in investor interest as a result."
On top of that, 10 or more countries in the region are on track to join the European Union, some as early as 2004. They are reaping the rewards of more direct investment, improved productivity, and increased trade. "Convergence with the EU is a powerful trend that can only drive stocks higher," says Alain Bourrier, a fund manager who specializes in the region at Merrill Lynch Investment Managers Ltd. in London. The best-performing Eastern European fund was DWS Investments' DWS Osteuropa, which returned 17.2% for the first quarter and 32.3% for 12 months. It took advantage of big rallies in several of the region's main markets, most notably the region's largest, Russia, which gained 30.7% in dollar terms for the quarter.
Of course, a couple of years ago, few Western investors would have ventured into emerging-market funds whatever their return. But after more than four years on the sidelines, punters finally were tempted by the bargain-basement prices of many of these stocks. Steffen Gruschka, a senior fund manager at DWS in Frankfurt, notes that corporate governance has improved in many markets, and that's being rewarded with higher prices. Take Russian oil producer Yukos. Its stock has tripled over the past year on the back of greater openness and better treatment of shareholders. "With Enron, the credibility of emerging markets doesn't look too bad after all," notes Mark Mobius, head of Templeton Emerging Markets Fund, which manages Templeton Asian Growth Fund, the first quarter's third-best-performing fund.
The big losers in the first quarter were funds specializing in technology, biotechnology, and telecommunications, which dominate the list of the worst-performing funds, giving investors haircuts of up to 23.69% for the quarter and 44.85% for the year. Their sorry performance came as a nasty surprise to the many institutions and retail investors attracted by their stellar performance in the final quarter of 2001. Sixteen of the top 25 funds in the fourth quarter were tech funds, but this time, 23 of the bottom 25 funds were tech, biotech, or telecom funds. Fund managers say the key reason for their sudden reversal was the lower-than-expected corporate investment in technology in both the U.S. and Western Europe.
Given their low prices, emerging-market funds are likely to continue setting the pace in the near term. But the big hope in fund offices from London to Hong Kong to New York is that the trend of investors returning to the developed world will soon begin to pick up speed. With the recovery strengthening by the day, that seems only a matter of time. By David Fairlamb in Frankfurt, with Frederik Balfour in Kuala Lumpur