The U.S. stock market is on a roller coaster, surging one day, slumping the next. Interest rates are climbing, and investors are on edge, waiting to see whether the U.S. economy has finally begun to slow. The prospects overseas are more promising: Europe is restructuring, and Asia is recovering. Most global fund managers expect those regions to pick up the slack. But even the most sanguine among them advise caution.
Playing it safe has never been more respectable: The risk of a blow-back into foreign markets from a severe decline on Wall Street can't be ruled out. Luckily, a diversified portfolio of global equities almost always produces the best returns over the long haul. For most people, a professionally managed fund is still the best investment choice. To get a sense of where the big gains came from so far in 1999 and where they might yet turn up, take a look at BUSINESS WEEK's annual ranking of the world's 500 largest offshore equity funds, with assets totaling $135 billion. These funds are based outside the U.S., often in such tax havens as Luxembourg or the Channel Islands. Their major appeal is that they withhold little or no tax on income or gains.
Since they are not regulated by the Securities & Exchange Commission, these funds can't be marketed to U.S. residents. But they do offer insights into where investors have been thriving--and where they might thrive in the future. Using data from the mutual-fund tracking service of Standard & Poor's Micropal, which like BUSINESS WEEK is a unit of The McGraw-Hill Cos., we give information on risk-adjusted performance, fees, expenses, and even top portfolio positions.
To rank the funds, we measure their gross returns against U.S. Treasuries, widely considered the global standard for riskless investing. Then we compare how the funds performed against the Financial Times/Standard & Poor's Actuaries World Index and rank them over one-, three-, and five-year periods through Oct. 1. This year, some 25 funds received an "A," our top risk-adjusted rating (table).
HIGH-TECH JOLT. The most successful fund managers bet on Japan, South Korea, and the Pacific region in general as well as technology stocks. Many are now scaling back their outsize stakes in U.S. companies. "Investors cannot expect the returns we've seen over the past few years," says John R. Ross, senior portfolio strategist with Fidelity International Ltd. in London. "Stock selection is going to be more important."
All the same, many managers are looking to high-tech stocks to give a jolt to their returns. As the Internet has surged to become a global force, telecom and cable companies have joined the once sharply inflated dot.com outfits in driving the market. Gary Lowe, London-based manager of the $1.8 billion Mercury Selected Trust-North American A Fund, for instance, likes San Jose-based Cisco Systems Inc., one of the infrastructure providers for the Net, as well as JDS Uniphase Corp., also in San Jose, which makes optical lasers that expand fiber-optic capacity. And Lowe keeps a substantial 6.1% of his fund in Microsoft Corp.
Despite the allure of U.S. high tech, many fund managers are casting their eyes toward the Continent. "Europe is more attractive than the U.S.," argues Michael A. Duffy, Arlington (Va.)-based managing director of the $4.5 billion Strategic Investment Management and $3 billion Emerging Markets Management funds. Some analysts, for example, like Europe's global players. Ahold, the Dutch retailer, can expect to garner growth from its U.S. and Asian operations, says Jacob van Duyn, chief investment officer of Rotterdam's Robeco Group and manager of its $7.5 billion flagship fund. He also figures that global drugmakers such as Glaxo Wellcome, Roche, and Novartis could do well next year.
Now that the euro is a reality, companies are gearing up to compete in a new market of 300 million consumers. Merger and acquisition activity is rising, with pace-setting deals such as Olivetti's takeover of Telecom Italia and Mannesmann's bid for Orange, the British mobile operator. Banking looks ripe for cross-border deals, too, with Spanish or German banks expected to lead the way. And investors could benefit from the newfound belief in shareholder value that is taking root. "Management in Europe hasn't received any strong pressure from shareholders for the past 10 years," says Claus Roepke, portfolio manager of the $109 million Frontrunner European Equity fund in Copenhagen. "But that is changing."
Higher inflation and interest rates could undermine corporate performance everywhere, though. European managers are protecting themselves by moving some money into cyclical stocks that benefit from price hikes, such as mining, engineering, or capital goods companies.
Asia still has its boosters, too. "A slowdown in the U.S. should be more than offset by an upturn in Asia," says James Squire, director of Asian equities for Baring Asset Management (Asia) Ltd., which manages $1.6 billion in non-Japan funds. And Japan is a big draw: All but one of 1999's top 10 funds are heavily invested there. The economy is growing slowly, but Japan Inc. finally seems serious about restructuring. "There are seismic shifts in Japan," says Elizabeth X.Q. Tran, chief investment director for Asia in the Hong Kong office of American Express Asset Management Inc., which manages $13 billion in international funds. "Although you will have to be patient, there is no question that the culture has changed." Multinationals such as Nissan Motor Co. and Sony Corp. are becoming role models by ditching their jobs-for-life policies, while banks such as Industrial Bank of Japan and Fuji Bank Ltd. are planning to rationalize operations. "I feel more comfortable about the prospects of making money in Japan," says Paul Kirkby, who manages $3.25 billion in Japan for Global Asset Management. More than one-quarter of his portfolio is invested in financials. But he prefers the likes of Orix Corp., Japan's top leasing company, or regional lenders to big money-center banks.
Not everybody is looking for companies to remake themselves, though. Analysts at Alliance Capital Management are high on Yamanouchi Pharmaceuticals Co., a solid performer in good times and bad. And betting that consumers will start to spend again, they like Kao Corp., the Procter & Gamble of Japan. Robeco Group analysts see technology players such as Fujitsu, Fujisoft, and NEC continuing to thrive on brisk demand for information-technology products. The same is true of NTT DoCoMo, the mobile-phone maker. "We are very positive on telecom," says Sophie Debehogne, Brussels-based portfolio manager of the $290 million equity telecom fund for Fortis Investment Management. "More and more people will be connected to the Internet. The sector is exploding."
Some Asian economies are growing at almost pre-crisis rates. South Korea's market put up a stellar performance earlier in the year, but concerns about how the government and creditors will handle the giant, debt-ridden Daewoo Group have cast a pall over it lately. Still, bright spots remain. Some analysts believe that Samsung Electronics Co. and Korea Telecom Corp. could be market beaters.
In Singapore, DBS Group Holdings Ltd. might be the beneficiary of the region's impending banking consolidation. Taiwan has its fans, too. "Taiwan has some of the best quality companies in the region that are growing very fast," says Mark J.T. Edwards of Rowe Price-Fleming International Inc., which manages $30 billion internationally. He likes semiconductor companies Taiwan Semiconductor Manufacturing Co. and United Microelectronics Corp. and component makers Hon Hai Precision Industry Co. and Asustek Computer Inc.
BETTER PROSPECTS. Many fund managers have been avoiding Latin America because they fear it could suffer if Wall Street takes a dive. But not everyone is convinced of that. Analysts like two phone companies, Mexico's Telmex and Brazil's Tele Centro Sul. "We've got a cheap region with better prospects coming up next year," says Salomon Smith Barney Latin America analyst Geoffrey Dennis.
Provided U.S. stock markets don't crash if the economy slackens, the impact abroad should be modest. But as long as there is the risk of a precipitate decline, fund managers worth their salaries are hedging their bets, ready to move once the trend is clear.