First Mexico fell apart in 1994-5, then Thailand and the rest of Asia in 1997, then Russia in 1998. By the end of the last decade, many developed-country investors had sworn off the volatile emerging markets for life. But memories are notoriously short in the investing world. Today, money is pouring into emerging markets again, with two former pariahs, Thailand and Russia, showing the most flash. And no wonder. During the past year, BusinessWeek's annual Offshore Funds Scoreboard reveals that emerging markets around the globe did nearly twice as well as other sectors. Indeed, in the 12 months through Oct. 1, offshore funds that invested in emerging-market equities enjoyed average returns of 43%, compared with 23% gains for those with global equity holdings.
In BusinessWeek's annual ranking of the world's 500 largest offshore funds, 8 of the top 10 performers were in emerging markets, with the remaining two in technology. And the returns were reminiscent of the high-flying 1999 technology markets; each of the top 10 funds gained at least 65%. Experts insist that it's not time to sell. "This is a multiyear bull market," says Mark Robinson, who manages the Emerging Europe Equity Fund and the Eastern Europe Equity Fund at JP Morgan Fleming Funds in London.
Thailand secured two of the top three positions, with the No. 1 slot going to Fidelity Investments' Thailand Fund, and No. 3 to Jardine Fleming (JF) Thailand. Both gained more than 80% -- by investing heavily in construction-related stocks, which benefited from a robust housing market, plus banking and telecom stocks. Overall, markets in Asia excluding Japan have seen an inflow of $3.4 billion in foreign money since May. And investors aren't finished yet. "I'd like to be overweight in every market [in Asia], but I can't," says Ajay Kapur, regional equity strategist at Citigroup Smith Barney in Hong Kong.
Money managers insist that they are not just chasing high returns -- but that there has been a big change in the way many developing nations do business. An overhaul of corporate and financial management, plus more enlightened government policies, make countries such as Mexico and Singapore less risky, they argue.
Moreover, in the last five years there has been a fundamental shift in global economics. The world's biggest manufacturers of everything from DVD players to steel beams are now located in developing nations, especially in Asia, and those companies are growing at a faster pace than their counterparts in Europe and North America. Local companies, along with global purveyors of consumer goods, are also making money selling into the growing internal markets of countries such as Brazil and Russia. "There has been an enormous development in Russia over the past two or three years," says Elena Shaftan, who manages a European emerging markets fund for ADIG in Munich. "There are big opportunities still to be exploited there."
But there are plenty of skeptics. Even the investors who have benefited from the recent run know 80% returns aren't sustainable. "In these smaller markets, you have no idea when liquidity may change or retreat," concedes Julian Lau, portfolio strategist at Fidelity Investments Management Ltd. in Hong Kong. "When too many retail investors move in, then one needs to be a bit more cautious."
Offshore funds are usually domiciled in tax havens such as Luxembourg and the Cayman Islands. Fund companies are not permitted to market their offshore offerings to U.S. investors because they aren't registered with the Securities & Exchange Commission. Nevertheless, the performance of offshore funds reflects market sentiment around the globe. Data on the world's 500 largest funds was compiled by Standard & Poor's and includes a risk-adjusted BusinessWeek rating of performance over five years. Like BusinessWeek, S&P is a unit of The McGraw-Hill Companies.
Beyond Asia, the best-performing funds over the past year made their bets on emerging Europe. Russian oil and gas stocks have shown healthy gains, helped by the new interest by Western oil giants in cementing Russian joint ventures. Russia has also benefited from federal tax reform, a perceived improvement in corporate governance, and a surge in consumer spending -- and borrowing. According to data compiled by the central bank, Russians are now paying back $6.2 billion in outstanding retail loans, six times the amount they owed in 2000. Says JP Morgan Fleming's Robinson: "In the past 24 months, you've seen a consumer boom in Russia that has been very, very intense. People are buying everything from mobile phones to microwaves to TVs." Russia's corporate elite have traveled so far along the road to transparency and reform that Moody's Investors Service just upgraded the country's sovereign debt to investment grade.
The bullish sentiment has driven the Russian Trading System index up 80% so far this year. But new investors should tread carefully. "Fundamental investors probably should not be moving into Russia," says James Fenkner, chief equity strategist at Troika Dialog, an investment bank in Moscow. "Unless you believe oil is going to be at these levels long, long into the future, it doesn't make sense."
Russia isn't the only former communist country rewarding investors. The Czech Republic, Hungary, and Poland are providing hefty returns as well. Fund managers say markets in Eastern Europe are soaring in anticipation of their membership in the European Union, set for next May, and their subsequent adoption of the euro, expected a few years later.
BANKING ON GROWTH
In Poland, unemployment remains distressingly high, as does the budget deficit. But foreign investors are pouring money into several hot sectors, led by telecom and banking. Fund managers like companies such as Telekomunikacja Polska, the former state telephone monopoly, which is cutting costs and raising revenues as it privatizes. Netia, Poland's largest privately owned provider of fixed-line telecom services, is also considered a buy. Investors also like Bank Pekao, Poland's largest private bank, controlled by UniCredito Italiano, Italy's largest banking group. Bank Pekao is the market leader in retail banking.
It's a similar story in Hungary and the Czech Republic, where offshore fund managers consider bank stocks to be great buys. A longtime favorite is OTP Bank Ltd., Hungary's biggest private bank, a core holding of the Griffin Eastern European Fund. Komercni Banka in the Czech Republic is another top pick. Like Polish banks, they are viewed as plays on the growing consumer market.
Impressed by the 80% and 70% rise in the Russian and Thai markets? The Brazilians aren't. Their Bovespa stock market index is up 98% since the beginning of the year. Likewise, Argentina's Merval index is up 95.3%. Such returns helped propel Latin American funds run by ABN AMRO and Schroder to fifth and 16th place in the BusinessWeek survey. Going forward, investors expect a U.S. economic recovery will boost growth in Mexico, which sends 87% of its exports to the U.S.
Beyond emerging markets, most of the best-performing funds during the past year were focused on technology (while many of the worst performers had their money in Japan, Korea, and health care.) JP Morgan Fleming's Europe Technology Fund, run by portfolio manager Ajay Gambhir in London, boasted a 65% return for the year ended Oct. 1. "There are opportunities in European technology, after a three-year tech recession," Gambhir explains. "But given the run we've had in the markets, one has to be selective." One of Gambhir's bets is a turnaround tale: He counts Sweden's battered Ericsson -- the world's leading maker of mobile-phone networks -- among his top holdings. After substantial job cuts in 2001 and 2002, Ericsson's stock has jumped 130% since the beginning of the year.
Some value investors with diverse portfolios outperformed too. The Classic Global Equity Fund, managed by Braun, von Wyss & M?ller in Zurich, turned in a strong performance by investing in a broad swath of companies, from financial firms like Credit Suisse and Zurich Financial Services to U.S. printer Consolidated Graphics Inc. Georg von Wyss, a partner at the firm, jokingly describes his fund as a "boring old value investor" that aims to buy shares of companies with strong financials but are being shunned by investors for some reason. "It's an investment style that works in the long run," says von Wyss. And the short run, too: The fund was up 63% for the year ended Oct. 1. By Laura Cohn in London, with Frederik Balfour in Hong Kong, David Fairlamb in Frankfurt, Geri Smith in Mexico City, and Jason Bush in Moscow