Mutual Funds: Riding The Waves Offshore
As Asia's economies have shriveled, those in Europe have boomed. The same pattern was reflected in the second quarter's performance of offshore equity mutual funds. Some analysts are starting to fret about a possible correction as European markets hit records, while others are looking for cheap buys as Asia's share prices plumb their lowest levels in a decade. But nothing suggests that the broad market trends will soon be blown off course.
Whether you want to ride Europe's momentum or bottom-fish in Asia, BUSINESS WEEK's Offshore Fund Scoreboard can help. Offshore funds, typically based in tax havens such as the Cayman Islands, are marketed only outside the U.S. Using data from Standard & Poor's Micropal (like BUSINESS WEEK, a division of The McGraw-Hill Companies), we track the world's 500 largest offshore equity funds on a quarterly basis. Historical data, with phone and fax numbers, can be found in the Nov. 10, 1997, international edition of BUSINESS WEEK or on the Internet at www.businessweek.com.
Picking the right region is key. Last quarter, the median fund lost 7%, largely because of Asia's dismal performance. Asia's first-quarter bounce fizzled, relegating funds invested in the region to the bottom of the barrel (tables). With Asia now moving into a sharp recession, there's no rush to buy.
In contrast, stocks in Europe--especially France, Germany, and the Benelux countries--are on a roll. There's a new optimism in Europe as the Jan. 1 introduction of the euro nears. Economic growth in the 11 participating nations is expected to hit 3% this year and at least the same in 1999, thanks to surging consumer demand. Already, the prospect of fiercer competition is forcing companies to shape up--and it's sparking a merger boom. Deregulation is giving newcomers a shot at long-protected industries, from airlines to telecommunications. A revolution in financial markets is gathering pace, with more emphasis on transparency, investor protection, shareholder value, and profits. Corporate earnings are expected to rise 18% this year and 16% next year, according to Goldman, Sachs & Co. "Consumers are starting to spend money, and Europe-wide corporate restructuring is starting to pay off," says Peter Sullivan, an equity strategist for Goldman Sachs in London.
European investors, who think a virtuous circle may be starting, are pouring money into equities as never before. In the first half of this year, nearly $50 billion flowed into European equity funds, according to Salomon Smith Barney. But the record surge doesn't portend a bubble, says the brokerage, because much of it is new long-term savings for retirement by people leery of relying on state pension plans.
The hot Belgian market paced several funds to sharp gains. And Germany, Europe's largest stock market after Britain, also looks set to maintain its fast pace. In the second quarter, it rose 16.5% in U.S. dollar terms, according to Morgan Stanley Capital International. Goldman Sachs figures that despite lower-than-average 2.7% economic growth, corporate earnings will rise a sizzling 25% this year and 15% next year. German companies are reaping the rewards of cost-cutting that they started ahead of their Continental neighbors.
With the benchmark DAX 30 index trading at more than 25 times 1998 earnings, there's not much room for error in picking big-cap stocks, warns Frank Fischer, head of S&P Micropal Germany. Still, savvy fund managers are finding plenty of action. Kurt Ochner, who runs Bank Baer Multistock Special German Fund, has 5% of his $175 million fund in software giant SAP, the only DAX stock it holds. Most of the fund is in midsize companies, such as luxury auto maker Porsche or printing-machinery giant
Heidelberger Druckmaschinen. Ochner has 20% of his portfolio in the sizzling Neuer Markt for small companies. Up 149% so far this year, it's considered too frothy by many managers. But Ochner is undeterred: "It's like the early days of [America's] NASDAQ," he says.
Europe's takeover wave still has a way to go. Amsterdam-based fund manager Anko Beldsnidjer, who runs ABN Amro Germany Equity fund, is looking to cash in on bank mergers. He likes Bayerische Vereinsbank--Germany's second-largest--which is positioned to roll out across Europe. "We're trying to play the transformation of Germany from an industrial to a more service-oriented society," says Beldsnidjer.
The French market played catch-up in the second quarter, rising 10.9%. Now, Salomon Smith Barney is looking for the benchmark CAC 40 index to rise 10% more by yearend. Certainly, if analysts' earnings estimates are right, more gains are on the way. Frank Benzimra, European strategist at Societe Generale in Paris, is figuring on rises averaging 15% annually over the next five years. The mood is buoyant because doubts about whether the Socialist-led government would maintain a strict economic policy have evaporated, cutting 10-year government bond yields to just 5%.
If Europe is easy to read, Japan is not. The world's second-largest economy has barely grown for a decade. It's frozen by policy gridlock and a succession struggle to replace Prime Minister Ryutaro Hashimoto. Investors may jump back into stocks if a new government promises permanent tax cuts, banking-system fixes, and eased monetary policy. Until then, stock prices are likely to be flat. "The market is heavily driven by policy statements," says Andrew Callender, investment head at Invesco Asset Management (Japan) Ltd.
Still, some fund mangers are moving back into stocks. Jardine Fleming's Japan Trust has scoured small and midsize companies for earnings momentum. Its 10 biggest holdings boast earnings gains averaging 20%. And the payoff is big price rises. The shares of Nidec Corp., a leading hard-disk-drive spindle producer, have more than doubled this year. "Japan as a whole looks very grim," says Richard Whittal, senior fund manager at Jardine Fleming Investment Trust & Advisory Co. in Tokyo. "But there are fantastic companies to invest in."
The real white-knuckle ride, though, has been Russia. The market fell about 76% from its October, 1997, peak to its July 8 trough. But even Russia has some boosters. Agreement on a new $22.6 billion International Monetary Fund package means the worst is over, says Peter D. Everington, chairman of Hong Kong-based Regent Pacific Fund Management Ltd., which has $1.5 billion invested in the Russian stock and bond markets. Russian bond yields spiked to 123% on July 14 but fell to 49% a week later, and Everington thinks they have room to fall to 35%.
REBUILDING. White Tiger Fund, the 10th-best performer over the past three years, lost 27% during the second quarter. The damage could have been even worse, but Regent had put 50% of its Russian funds' assets into cash and short-dated bonds. Now, it is rebuilding its equity position with big-cap stocks, such as Rostelcom, the phone company, and United Energy Systems, a big electric utility. Both generate a lot of cash and sell at low valuations.
Asian funds fell to earth with a thud. Fidelity's Thailand Fund was up 39% in the first quarter but dropped a stomach-wrenching 52% in the last quarter. It has lost two-thirds of its value since the Asian crisis began a year ago, and little relief is in sight. Alfred Ho, Hong Kong-based director of Invesco Asia Ltd., worries that bad debts are far worse than initial estimates, so it will be a lot costlier to fix the financial system than originally thought.
Around Asia, the story is much the same. Korean funds dominated winners' lists in the first quarter but dropped sharply in the second. The outlook isn't encouraging. The giant chaebol are resisting the wholesale shakeups they need. And it may cost $90 billion to recapitalize Korea's ailing financial sector, say official estimates. Meanwhile, the high interest rates needed to protect the Hong Kong dollar's peg to the U.S. dollar are hammering property and stock prices. "[Asia's] economies are going to contract much more severely than we expected," says Ho.
PATIENCE. Although China's economy is slowing, some fund managers figure there's value to be had. Cheah Cheng Hye, managing director for Hong Kong-based fund manager Value Partners Ltd., has moved three-quarters of his $145 million fund into China-related stocks. He's finding beaten-down companies with 12% to 18% earnings growth selling at just eight times earnings. A typical example is washing-machine maker Wuxi Little Swan, whose shares nearly halved in price in the first two weeks in July. "It's a once-in-a-lifetime opportunity," says Cheah. But he may need a lot of patience. As with most investing, it's the long haul that counts. The yo-yo fortunes of Asian funds is a reminder of how easy it is to be misled by a single quarter's data.