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International Plays For Investors With Steely Nerves


Pity the fund manager who once looked for familiar names in emerging markets when he wanted to provide a quick pop in returns. These days, conservative fiscal policies, ample foreign reserves, and easy access to capital have reduced the risk premium in once iffy markets from Brazil to Thailand. Stocks in most of these markets are flat or in single-digit territory so far this year, while yields on emerging-market bonds are just a few percentage points higher than U.S. Treasuries. That's in spite of the Federal Reserve's latest round of interest rate hikes, which typically widen the basis point spread between Treasuries and emerging debt.

So where do investors with an appetite for risk go in search of higher returns? Increasingly, it's to investments well off the beaten path: Kazakhstan, Serbia, Ukraine, or perhaps even Iraq. That's because easy bets on emerging-market recoveries are no longer yielding big payoffs. "There was a time when you could make pretty good money based on turnarounds," says Fred Sykes, a managing director at New York's NWI Management LP, an emerging-markets hedge fund that manages $1.6 billion. "But now you're starting to see the reemergence of the more traditional high-yield, leveraged investments."

Of course, daredevil plays are only for investors with cast-iron stomachs -- and money they can afford to lose. Even then, fund managers say exposure is usually limited to a tiny fraction of a typical portfolio. But interest in more exotic securities is growing, particularly among hedge funds and wealthy individual investors.

Just because an investment is off the beaten path doesn't necessarily mean it's speculative. Take Egyptian mobile-phone operator Orascom Telecom Holdings, the biggest nonoil company in the Middle East (BW -- Mar. 21). Most of its revenues, which soared 93% last year, to $2 billion, come from Algeria, Egypt, and Pakistan. Net income nearly tripled, to $298 million, helping it pay off more of its $764 million debt load. Investors have taken note, sending its stock price in Egypt up 60% during the past six months.

Or how about a commodity-linked play that provides double-digit returns? Ukrainian steelmakers Azovstal and Zaporizhstal, whose American depositary receipts (ADRS) trade on the New York Stock Exchange, are popular investments among fund managers fond of Eastern Europe. The caveat is that Ukraine's steel sector still suffers from poor transparency and the country's murky politics, plus there's the risk of a cyclical downturn in steel prices. But for now, these companies are on a roll. Azovstal's revenues increased from $690 million in 2002 to $1.7 billion last year, while Zaporizhstal's rose from $634 million to $1.2 billion. They are earmarking the extra cash to replace outmoded equipment and boost productivity. "The steel market is at a peak, and steel companies are reporting higher earnings," says Andriy Dmytrenko, head of research at Kiev brokerage Dragon Capital.

Want to make another adventurous bet in the former Soviet Union? The four main banks in oil-rich Kazakhstan, including Bank TuranAlem and Kazkommertsbank, are raising capital by issuing dollar-denominated bonds. Hedge funds and other daring investors like the banks because they have implicit government backing. That's something credit-rating agency Moody's Investors Service (MCO) cited in its upgrade last fall of the banks' near-investment-grade Ba1 long-term foreign currency deposit ratings from "stable" to "positive."

One of the risks of far-flung markets with poor regulation is a lack of dependable financial data. An exception to that rule in China is Yanzhou Coal Mining Co., which is listed in Hong Kong and Shanghai and has an actively traded ADR on the NYSE. Its stock price has risen 20% in the past 12 months. Yanzhou serves big customers at home, such as Shangdong Power & Fuel Co. and Shanghai Baoshan Iron & Steel, and it has a thriving export business to Japan. "At this stage, China needs to power growth, and coal is about the only energy source they have," says Michael A. Marusiak, a portfolio manager at Principal Global Investors in Singapore.

A Bet on Iraq

for a walk on the wilder side of the fixed-income market, look no further than distressed Iraqi debt. Back in 1990, the government of Saddam Hussein defaulted on $120 billion in loans in the runup to the first Gulf War. Some of that debt may be written off by the U.S. and its allies, but the rest will probably have to be repaid once Iraq is back on its feet -- probably at a big discount. The successful Iraqi elections in January, and International Monetary Fund projections for 9% growth in 2006, have led investors to pay up to 30% of face value for the Iraqi debt in a market with trading volumes approaching $500 million a year, roughly the size of the Ivory Coast's debt market. "Investors who have a long-term horizon find it attractive," says Richard Segal, director of research at Exotix Ltd., a London brokerage specializing in illiquid bonds.

Serbian debt is attracting investors as well after the Balkan country struck a debt-forgiveness agreement last July with creditors who agreed to restructure remaining loans into a new bond offering. Indeed, yields on defaulted Serbian debt obligations tracked by Exotix are down to 7%, half the level of two years ago. At the same time, some investors are taking a closer look at Serbian equities. Candymaker Bambi, based in Pozarevac, Serbia, has attracted European investment, as have builder Energoprojekt and drugmaker Hemofarm, all of which have share prices that have at least doubled in the past two years.

A way of adding extra sizzle without increasing credit risk is to invest in local currency issues. For example, although yields on Ukrainian T-bills have declined to 7% in recent months on high demand, the dollar's decline against the local currency, the hryvnia, means the equivalent dollar yield is above 12%. "It's an area that's more attractive now because you have the potential for [local] currency appreciation [against the dollar]," says Kristin Ceva, lead strategist for Los Angeles investment management firm Payden & Rygel's Emerging Market Bond Fund.

Investors who want high returns and are willing to wade into riskier securities to get them need not put all of their nest eggs in emerging markets. Catastrophic fixed-income investments, or cat bonds, are an alternative that offers the prospect of returns as high as 20%. Cat bonds are created by repackaging insurance policies against natural disasters like earthquakes into bonds. The market has been around only since the mid-1990s, but it's worth $1.1 billion a year today. The bonds' chief advantage: Natural disasters usually have little of the "contagion risk" shared among emerging markets. "To the best of our knowledge, there has never been a loss of principal from a cat bond," says Judith E. Klugman, a managing director at Swiss Re in New York.

Of course, that might change with the next big hurricane. But even if some investors take a licking, the lure of higher yields will draw others. For the daredevil investor, the search for one more high-payoff risk never ends.

By Brian Bremner in Tokyo and Chester Dawson in New York, with Laura Cohn in London and Jason Bush in Moscow


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