All Clear Ahead For Offshore Funds?

Europe and the U.S. were winners in the fourth quarter; Asia remains risky

You're wondering where to invest in 1998 and thinking about which offshore equity funds to buy. So you decide to do a quick check of the world's stock markets to see where you might be best off. No one will fault you if you emerge from the exercise feeling confused.

Consider the U.S. The economy remains strong and inflation and interest rates low. But after more than seven years of record-shattering gains, American equities aren't exactly cheap--and Asia's financial troubles have dealt Wall Street a few scary blows lately.

Is Europe a better alternative? The economy certainly looks hot, as interest rates remain low and most of the European Union rushes toward a single currency next year. But Euro equities are hardly bargains, either. So perhaps it's time to turn to Latin America. Stocks aren't as expensive there, and most of the major economies are holding up well. But every time Asia has quaked, Latin markets have tumbled in sympathy. And that brings you around to Asia, where investors have been running for cover for months.

Some Asian funds plunged as much as 60% in the last quarter as a deepening currency crisis sent bourses into a free fall. With the International Monetary Fund rushing emergency loans into the region and many markets showing signs of recovery, is it time to jump back in and snap up bargains? Or will today's bargains be even better buys a few months down the road if the current glimmerings of optimism prove short-lived? Says Invesco Asian Development Trust manager Bill Barron: "I can see light at the end of the tunnel. But I can't see the earnings."

GO EASY. No one knows when Asian earnings or funds will bounce back conclusively, of course. But we can help you make sensible investment choices nonetheless. In these pages, we review the returns posted by the world's largest offshore equity funds during the fourth quarter and highlight the best and worst performers. We've also consulted investment strategists to see where they advise putting your money. Many think now is not the time for derring-do. "We find more attractive companies in the U.S.," says Jaap van Duyn of Robeco, whose group racked up losses in Asia last year. He's now concentrating on American technology issues, including Schlumberger, Xerox, and Motorola.

Whether you like U.S. tech stocks or are more comfortable with Europe or other markets, offshore funds give you an easy way to focus your investments. Many specialize in specific countries, regions, or industries. Offshore funds are mutual funds that are usually domiciled in such tax havens as the Channel Islands, Cayman Islands, or Switzerland and only sold outside the U.S. Using data provided by Standard & Poor's Micropal (like BUSINESS WEEK, a unit of the McGraw-Hill Companies), we rate funds by adjusting returns for the amount of risk managers have taken with your money over the last five years. You can find our ratings in the Nov. 10, 1997, issue of BUSINESS WEEK's international editions online at the Investors Central area of BW Plus! on or on America Online (keyword: BW).

You'll find several top-rated funds--nearly all of them focusing on the U.S. or Europe--among the fourth quarter's best performers. The quarter's leader: GAM GAMCO, managed by Wall Street veteran Mario J. Gabelli. Another top-rated performer was JF American Growth, up 5.13% for the quarter and 37.98% for the year. Indeed, the U.S. continues to rank highly in many strategists' picks for '98. And why not? Auto sales and payrolls remain robust, and low long-term interest rates should bolster housing and other industries. That may help explain the resilience of the Standard & Poor's 500-stock index. It suffered three drops of 5% or more last year--the most since the U.S. bull market began in October, 1990. But each decline was quickly recouped. Even with the U.S. economy expected to slow later this year, Standard & Poor's Outlook is still forecasting a 9% total return for the S&P 500 in 1998. True, that's less than a third of the 31% recorded last year. But it's still close to the 11% return over the long term.

DEFLATIONARY WINDS. That Europe continues to shine is little surprise, either. Credit Suisse First Boston expects economic growth to inch up to 2.5% in 1998 and spurt ahead to 3.2% in 1999 after hitting an estimated 2.4% last year. Moreover, corporate profitability is rising as a wave of mergers takes aim at overcapacity and overhead. The Asian financial crisis will even "have a silver lining for European stock markets," maintains strategist Francois Langlade-Demoyen. The deflationary wind blowing from Asia will "lead to lower European interest rates" and help buoy earnings. All told, he figures, European equity markets will rise 15% in 1998. That would be good news for Alexandre Deveen, manager of BBL (L) Invest Telecom & Media. He has stocked up on Telecom Italia, Telefonica de Espana, and France Telecom. Meanwhile, Pierre Pinel, manager of Parvest Switzerland, is betting on a rising tide of financial industry mergers and is buying Swiss banks and insurers.

Skies seem reasonably clear for markets in Latin America--as long as Asia's troubles don't further unnerve global investors. The fourth quarter was a rough one for many Latin funds: On average, they finished down 12.6%. But Latin governments are taking steps to bolster investor confidence. For example, amid concerns that Asian devaluations might force Brazil to follow suit, Economy Minister Pedro Malan has trimmed his government's budget and slashed planned capital investments by state phone and oil companies.

The cuts, and high interest rates, may slow Brazilian economic growth to 1% this year, a third of 1997's rate. But investors have been encouraged by news that Brazilian inflation was down to a mere 4.6% in 1997, the lowest rate since 1950. Inflation in Argentina and Mexico remains subdued as well, even with economic growth expected to remain above 5%. Signs such as these are prompting big investors to move more cash into Latin America. A Gallup poll for Merrill Lynch & Co. in January, for example, indicated that nearly a third of global fund managers surveyed are now bullish on Latin stocks, up from 10% in December. But Merrill's chief Latin American strategist, Eduardo M. Cabrera, as well as Salomon Smith Barney strategist James W. Barrineau, recommend that for now, investors stick with the big capitalization markets--Argentina, Brazil, and Mexico.

If the outlook is decent for much of Latin America, it's still less rosy for Asia. Investors are taking heart from IMF rescue packages and plans by the Japanese government to shore up the nation's sagging banks. Indeed, BBL manager Deveen is thinking of sailing east to bottom-fish. "Telecom operators there have lost so much value that they could become interesting," he says.

STEEL PICKS. Jung Rhee, who runs the $25 million Baring Korea Feeder Fund, is also becoming more bullish. At the end of last year, Rhee had 25% of the fund's assets in foreign currencies as the won plunged. He's now fully invested in South Korean stocks, focusing on exporters with sound balance sheets, domestic companies with strong market shares, and global players in businesses such as semiconductors and steel. Among his picks are Pohang Iron & Steel, Samsung Electronics, and SK Telecom, a cellular-phone carrier.

Still, market-watchers caution against over-optimism. Markets rallied in mid-January, but further disappointments could lie in wait. Hong Kong is likely to see interest rates rise and residential property prices plunge after falling a quarter since August. And who knows what corporate profits will be.

Sure, estimated 1998 price-earnings ratios have skidded to a tempting eight in South Korea, Indonesia, and Thailand, and nine in Hong Kong. But "in the midst of a financial crisis, traditional valuation measures and growth forecasts are suspect," warns Salomon Smith Barney analyst Brian Gendreau. "Sharp swings in exchange rates and interest rates of the type that have become all too common in Asia can make earnings forecasts seriously out of date in a matter of weeks, if not days." When you're picking funds, those are words well worth considering. Even if the bargains are abundant, it may be better to stick with the tried and true markets and funds for a while longer.

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