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Go East, Intrepid Investor

Personal Business: SMART MONEY


The bull market in U.S. equities is showing signs of severe fatigue, but that doesn't mean you have to forfeit those double-digit gains you've grown accustomed to. However, you may have to start looking in a different direction: east. No, not to the much-acclaimed markets of Southeast Asia but to the booming bourses in Eastern Europe.

Over the next five years, emerging markets in general are expected to be the best-performing asset class, according to a KPMG Peat Marwick survey. Poland, Hungary, the Czech Republic, and yes, even Russia, should lead the pack, offering phenomenal growth at low multiples. Many of the public companies currently have a price-to-earnings ratio of around 7.5 and an earnings-per-share growth rate of 35% to 40% annually. "This is a historic window of opportunity for investors. Returns are excessively high, and valuation levels are extremely low," says Arpad Pongracz, manager of Vontobel Eastern European Equity Fund, the only open-end mutual fund to focus solely on the region. Since the fund's inception in February, Vontobel is up almost 37%.

NO LOCKSTEP. The recent instability of the U.S. market has reinforced the importance of diversification, especially overseas. "Eastern Europe, notably Poland, is a compelling way for investors to hedge the U.S. stock market or redeploy profits," says Suzanne Patrick, a senior analyst for Central European research at Arnhold & S. Bleichroeder in New York. Although these markets were down slightly the week of July 15 in reaction to the volatility in U.S. stocks, Merrill Lynch research shows that long-term correlation between Eastern Europe and the U.S. appears low.

Investing in Eastern Europe is also a way to play the dollar's strength. With growth in gross domestic product ranging from 4% to 6%--almost double that of the U.S.--Poland, Hungary, and the Czech Republic are increasing exports to dollar-based world economies at a rate faster than industrialized Europe, says Douglas Johnson, senior strategist at Merrill Lynch in New York. For example, Poland's exports to the U.S. over the past two years have been growing at an annual rate of 27%, compared with the 11% average for the major European economies.

Granted, developing Europe and Russia are not for the skittish. "Anyone who invests in these markets really has to be a long-term player," says Richard Saler, manager of Lexington Worldwide Emerging Markets Fund, which presently has a 15% stake in Eastern Europe and year-to-date returns of 9.07%. "The fundamentals can be good, and the market can still go down 10% to 20% on any given day." Patrick Smith, manager of the Pioneer Europe Fund and one of the first money managers to take a big position in the former Eastern bloc, made 100% in 18 months. Content with those results, he has already cashed out.

FEW PURE PLAYS. But others are just jumping in now. Hoping to capitalize on the growth of Russia's burgeoning free-market economy, Lexington Management and Troika Dialog Asset Management in Moscow launched the first open-end Russia fund--the Lexington Troika Dialog Russia Fund--immediately after President Boris Yeltsin's reelection in July. The most volatile emerging market, Russia is up 85.53% in dollar terms so far this year, according to the ASP General Price index.

For now, pure plays are few. American Depository Receipts (ADRs) that allow direct investment are hard to come by. GUM, a Russian retailer, is one trading currently. But Arnhold & S. Bleichroeder--which this fall is placing the first Polish ADR, Mostostal-Export, a construction holding company--anticipates that more will follow in the next year. While there are a handful of single-country closed-end funds, such as the Czech Republic Fund, the safest and most accessible means of entry is a diversified emerging markets fund. Robertson Stephens Developing Countries Fund, up 27% for the year, is more heavily weighted in Eastern European countries than most other offerings in its class. It also has one of the best returns among its peers year-to-date: 19.58%, according to Morningstar.

Remember, emerging markets are high risk, and they should only account for a small portion--5% to 10%--of your overall allocation of assets. That said, however, if you're thinking about investing here, don't wait long. "When you see unique opportunities opening up like this one, you have to get in there," says Sheldon Jacobs, editor of The No-Load Fund Investor. While it has taken years for the Eastern European countries to make the transition from communism to capitalism, the chance to buy into their markets at the bottom probably won't last long.EDITED BY AMY DUNKIN By Kerry CapellReturn to top

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