The Rise of East Europe

David Masters
Associate Editor, Micropal Emerging Market Fund Monitor

At the end of 1994, East European equities accounted for only 3.2 per cent of global emerging market equity funds' holdings. At the halfway point of 1997, according to the Micropal Emerging Market Fund Monitor, this figure had risen to nearly 8.5 per cent. In that same time, assets under management in both regional and single country funds targeting East Europe equities had risen from just over $1.5 billion to nearly $10 billion.

Since December 1995, the performances of some of these East European markets has been a tremendous lure, with Russia notching up a 341.23 per cent increment, Hungary climbing 174.51 per cent and Poland gaining 60.01 per cent. Compare these figures to the 14.96 per cent gain in the IFCI Composite Index, the 41.82 per cent increase in the IFCI Latin America Index or the 6.98 per cent drop in the IFCI Asia Index.

The booming Russian market has been the main attraction thus far. At the end of 1994, Russia accounted for only 0.5 per cent of the average global emerging market equity fund portfolio, today it accounts for over 4 per cent (rnaking it the eighth largest holding). Assets under management in dedicated Russia and CIS equity have grown from $240 million to $3.5 billion, whilst East European regional funds have increased their allocations to Russia and the CIS from five per cent to around 25 per cent.

Obviously, this represents fund manager reactions to an increased opportunity. The real growth in Russian investment has been since Yeltsin was re-elected to the presidency, and fund managers have increased holdings in both Poland and Hungary, whilst the levels of investment into the Czech and Slovak republics has reduced.

East European market performance

In terms of performance, both 1994 and 1995 were poor years. In 1994, the 9 East European funds monitored by Micropal declined an overall 15.18 per cent, with none of the funds recording positive returns. The following year matters had improved slightly, with the funds (now 24) averaging a 4.21 per cent decline, led by Bank J Vontobel's Luxembourg-domiciled Vonotobel Fund - Eastern Europe Equity A Shares, gaining a relatively impressive 10.52 per cent. In 1996, matters improved considerably, with 33 funds returning an overall gain of 49.33 per cent, led by Mercury Select Trust Eastern Fundwith a 137.95 per cent. In the first seven months of 1997, 47 funds have returned an average 21.52 per cent, with Invesco CEAM's East Europe Development Fund Ltdleading the way with a 75.91 per cent gain. This fund is also the top performing East Europe fund over the last five years. The fund has returned 788.13 per cent since 31 July 1992 and 825.13 per cent since its inception at the end of 1990. This is equivalent to 54.83 per cent and 40.18 per cent on an annualised basis. Interestingly enough, the fund achieved only a 1.78 per cent gain in its first 11 months.

Invesco's fund does differ from its rivals in a number of ways. Firstly, it has been in East Europe for much longer than any of the competition. Secondly, the fund's investment policy has been centred around early entry into the East European markets, often targeting small, unlisted development capital projects. Thirdly, it currently has around 70 per cent of its assets invested into Russia and the CIS. This is the highest of all the funds in the same category, and indeed, higher than some dedicated Russia funds. Compare the overall asset allocation chart above with the chart below, outlining the historical evolution of INvesco's fund.

It is interesting to note the similarity between the Invesco fund allocation for first quarter 1995 and the overall allocation second quarter 1997.

All of the leading performers of East Europe Regional Equity funds have a high Russian weighting. If we look at those few funds with either little or no investment in Russia, we see considerably different performance. Credit Suisse's London-listed closed-end Central European Growth Fund plc is the largest fund ($288 million) to have no allocation to Russia. As the chart below indicates, the fund is currently lagging behind its peers in performance terms.

Recently, fund management companies have started to launch new East European funds on a regular basis. ' This year to date, over ten regional equity funds have been launched, plus half a dozen Russian equity funds, and a smattering of debt funds, both regional and country specific. This year has also seen the launch of the first 4 commercially available Ukraine equity funds and first two Ukraine debt funds, plus the launch of the first four Romania funds and the first Balkan equity fund. In part, this is due to the massive hike in Russian stock prices, but also because the region is liberalising rapidly and opportunities are arising. How much longer this euphoria lasts remains to be seen, however.

Baltic equity graph

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