Fleeing The Bears, Finding The Bulls

Offshore investors found refuge from Wall Street in many emerging markets

Wall Street's jitters over rising U.S. interest rates and slowing corporate profits have many investors looking at meager returns so far this year. But some are smiling broadly. As the first-quarter update of BUSINESS WEEK's Offshore Fund Scoreboard shows, more than a few money managers investing in emerging economies have managed to turn in rip-roaring results.

For the second straight quarter, the odds-on winners among the 500 largest equity funds overseas were a trio of Russia funds with similar portfolios: Regent Red, White, and Blue Tiger. Although the 500 posted a mean return of just 1.7% in the quarter, Regent's Tigers were up some 60%, and more than 300% for the past 12 months (table, page 64) on the back of a market that is up 45% this year. But while Regent's gains in Russia were extraordinary by any measure--and, money managers say, may be hard to sustain--Moscow was hardly the only emerging stock market to give offshore funds a lift. Among other stars were funds investing in Brazil, eastern Europe, Taiwan, and even India, whose stock market started rebounding a few months ago after falling through much of 1996. Investors in these funds took home as much as 10 times the 2.7% gain that the Standard & Poor's 500-stock index delivered in its weakest quarter since early 1994 (chart). SECOND HIT? By contrast, the quarter's big losers were concentrated in a few sectors that for months have not been able to shake the stigma of defeat. Funds investing in U.S. high-tech stocks haven't recovered from the shakeout that hit the high-flying sector nearly a year ago. Indeed, if anything, the retrenchment has spread amid fears the Federal Reserve will respond to a strong U.S. economy by soon hiking rates a second time.

Thailand funds, meanwhile, have been taken to the cleaners as the Bangkok stock market reacted to mounting trade deficits and spreading banking industry problems with a stunning 50% retreat since 1996. And many Japan funds, clobbered by a massacre in blue-chip bank issues and a declining yen, lost a fifth of their value or even more in the quarter alone. The losses in Japanese and Thai funds have been so extreme, in fact, that some intrepid analysts now think they're the bargains of the year. "The Asian miracle is not dead," says Michael J. Howell, director of London's CrossBorder Capital.

Neither is Wall Street's own miracle market, by many analysts' reckoning. And there are opportunities in European funds, too. Indeed, winnowing out winners from losers--and finding the best bargains--is what the Offshore Fund Scoreboard is all about. Offshore equity funds are mutual funds that are domiciled in such tax havens as the Channel and Cayman islands, Luxembourg, Bermuda, and Hong Kong and are sold to investors outside the U.S. Offshore funds choose not to make the extensive Securities & Exchange Commission filings required to sell funds in the U.S. As a result, most funds decline to sell to U.S. residents or citizens.

Using data supplied by Micropal Ltd., a London-based mutual-fund research service, we sift through the results of the largest offshore equity funds every quarter. In addition, we produce exclusive ratings of the funds each fall, based on their performance, in U.S. dollars, over the past 12 months, adjusted for the amount of risk each fund takes. (You can find the 1996 Scoreboard on the Internet at http://www.business week.com/1996/46/b35016.htm).

The story of the first quarter's biggest winners is simple. Dominic Bokor-Ingram, manager of Regent Kingpin Capital Management Ltd.'s three Russia funds, bet on a few stocks in what has been one of the most ebullient markets on earth. Among his picks: Noyabrskneftegaz, an oil and gas producer in western Siberia whose shares have doubled in recent months, and Unified Energy System, a big electric utility that gained more than 200% in the quarter. But after Moscow's wild ride, Bokor-Ingram and his colleagues have begun to turn wary. "The market has had an amazing run," says Bokor-Ingram, "but we haven't had much good economic news coming out of Russia this year." In fact, Moscow stock prices have already declined 12% since Feb. 21, and until he sees clear signs of industrial rebirth, Bokor-Ingram believes stocks now are in for "a quiet period." But over the longer haul, he still sees "huge potential" for growth. Another big investor in Russia is Ewen Cameron Watt, head of emerging markets at London's Mercury Asset Management Group PLC, whose Mercury ST Eastern European fund rose nearly 30% in the quarter. Despite reservations about the poor state of shareholder rights in Russia, he still has nearly a third of the fund's assets there. But he also finds good buys elsewhere in the region. He is fond of eastern European pharmaceutical makers, which trade, on average, at only twice book value--a third of the valuation of their Western European counterparts. Among his favorites is Pliva, a Croatian drugmaker whose Xithromax, a patented component of antibiotics, is making inroads in Western Europe and the U.S. He also is enthusiastic about the Baltic republics, where he likes Vilniaus Bankas, Lithuania's largest commercial bank. With its assets expected to grow 30% this year on top of 25% in 1996, "we think it's a wonderful company," Watt says. "It's underrecognized."

While Russia and eastern Europe have been the Cinderella markets of the year, other fund managers have been focusing on South America. To Florian Bartunek, manager of Rio de Janeiro-based Banco Pactual's Eternity and Infinity funds, that means shunning the blue chips most international investors favor for "winners that have not yet been discovered." The funds, which have similar portfolios, saw their net asset value grow by over a third in the quarter by concentrating on such smaller companies as Telefonica Maranho, the phone company serving Brazil's remote but fast-growing northern state. Bartunek is also buying Lojas Arapu, an appliance and electronics retailer benefiting from an increase in the availability of consumer credit since the government launched its three-year-old currency reform plan.

WASHOUT. South and East Asia are also cooking up profits for investors. Diahann Brown, senior fund manager with Thornton Taiwan Equity fund, has been buying automotive, electronics, and construction stocks, which have been hot since the government began stimulating the homebuilding industry after a six-year downturn. With Taiwanese stocks up 21% this year, Brown has turned "more cautious" lately, "but in 1998, we think earnings will recover and the market will pick up again."

Another fund that's making a bundle in Asia is JF India Trust. Most of last year was a washout for India investors, with stocks down a third between June and early December. But Patrick Wong, investment director of Hong Kong's Jardine Fleming Unit Trusts, rushed back into the market on the eve of the government's budget announcement in February, buying such blue chips as Reliance Industries and Tata Engineering & Locomotive. With analysts figuring that the budget's proposed tax cuts would boost corporate profits sharply, stocks immediately surged 13%. And even though the coalition government led by H.D. Deve Gowda resigned on Apr. 11 after surviving only 10 months in office, Wong remains optimistic that economic reforms will continue under newly named Prime Minister Inder Kumar Gujral. "The market realizes it's just personal dissatisfaction with the [former] Prime Minister," Wong says, "not with the government's policies, which will probably stay."

While emerging markets are providing much of the excitement these days, the bourses of the industrial world still offer their share of potential rewards despite interest-rate fears. For example, Marnix Vriezen, Rotterdam-based manager of Robeco's RG America fund, admits to taking "a very cautious view" of the U.S. market. He expects operating earnings growth to slow to 6% or so this year, a third of what some bulls expect, and thinks it's "quite possible" the Federal Reserve will raise interest rates again before long. "The best of the bull market is behind us--the easy money has been made," he says. As a result, Vriezen is moving more cash into Canada, which, he observes, has managed to cut its current account deficit in half and achieve even lower inflation than the U.S. But he is hardly abandoning the States. He continues to like a bunch of blue chips whose earnings have remained strong, including Pfizer, Merck, Lucent Technologies, and Microsoft. HARD TO BEAT. Another way to play the U.S. market is to look for high yields. That's what Patrick J. Yam, executive managing director of Bermuda-based Private Capital International Ltd., is doing. His recently launched PCI-Bay Real Estate Equity fund is buying into U.S. real estate investment trusts, which are publicly traded companies that own commercial and residential properties. Yam notes that the fund's portfolio of REITs now boasts dividends of around 7%. Moreover, its manager, San Francisco's Bay Isle Financial Corp., has more than held its own in a number of stock market slowdowns in the past. In 1994, when the S&P was up only 1.3%, Bay Isle's REIT holdings advanced 6.6%. Last year, Bay Isle clocked a 36.2% return, 13 percentage points better than the S&P.

If Wall Street continues to cool, those numbers may be hard to beat in 1997. So many other money managers are looking toward continental Europe for performance. Although the Continent's bourses have advanced smartly this year in anticipation of an economic upsurge, Charles H. Brandes, the San Diego money manager who picks stocks for Oxford Strategic fund's International Equity Value portfolio, still thinks stocks in France, Italy, and Spain have a way to go. Among his top picks are French telecom equipment maker Alcatel-Alsthom and Telefnica de Espaa, the Spanish phone company that's on an expansion binge overseas. On Apr. 18, Telefnica formed an alliance with British Telecomunications and MCI Communications to expand further in Latin America, where the Spanish carrier is already a leading player. Although its stock has more than doubled over the past four years, Brandes thinks that it's still cheap relative to its cash flow. "It's a growth stock," he says. "We like it."

Looking for growth stocks--at the right price, of course--is the name of the game. It's a game that is growing more challenging on Wall Street these days. But there are plenty of funds offering ways to play other markets where the bulls are still running fast.