Offshore Funds: Asia Shakes The Flu

Europe and U.S. tech are hot, too, but watch out for Latin America

It's the great Asian rebound. Cheered by tough reforms in such trouble spots as South Korea and Thailand, Asian offshore equity funds surged back to life in the fourth quarter of 1998. As BUSINESS WEEK's fourth-quarter Offshore Equity Fund Scoreboard indicates, even investors in recession-bound Japan began to see signs of hope, easing some of their longstanding worries about the region. Europe, meanwhile, continued its hot performance string, while investors in U.S. technology funds reaped the benefits of heavy capital spending and Internet stock mania. The big question now: Latin America, where investors and analysts are keeping their fingers crossed in light of Brazil's currency turmoil.

Using data from Standard & Poor's Micropal (like BUSINESS WEEK, a unit of The McGraw-Hill Companies), we track the world's 500 largest offshore equity funds. These funds, typically based in tax havens such as Luxembourg, do not file reports with U.S. regulators and are marketed only outside America. Detailed historical data on the funds are at our Web site,

What's behind the Asian rally? More than a year of plunging markets created "tremendous devastation," says Douglas M. Wilde, global investment strategist for Merrill Lynch & Co. Investors were panicked by the free fall of East Asian economies that began in 1997 and continued into the first half of '98. Private long-term capital flows into the region shriveled from $42 billion in the first half of 1997 to $13 billion in last year's opening half, according to Morgan Stanley Dean Witter. "In Korea, the stock market went through the floor, the exchange rate went through the floor, and interest rates went through the ceiling," says James P. Rooney, CEO of SsangYong Templeton Investment Trust Management Co. in Seoul. "Everybody was frightened to death."

FRESH BREEZE. Then suddenly last fall, "the panic phase was over," observes Jeff Kung, director of research for Fidelity Investment Management in Hong Kong. Once reforms began falling into place and the U.S. and other industrial countries started slashing interest rates, markets stabilized. But even in Asia, gains were anything but universal. Funds investing in Taiwan and India, for instance, were among the quarter's worst performers. Taiwan was buffeted by a downturn in electronics and financial scandals, while nuclear weapons tests and political woes kept India on edge.

But with interest rates falling from 30% at their peak to around 8% recently, South Korea excelled. It drew praise because of reforms in its banking system and sharp gains in its current account that drove up liquidity and brought down rates. "Korea is more willing to restructure and more willing to let foreign investors take part," says Fidelity's Kung, whose Korea fund was the quarter's No. 1 performer.

Similarly, Thai funds also rebounded as investors perceived that Bangkok was sticking with the reforms demanded by the International Monetary Fund aimed at cleaning up the economy and bolstering the battered baht. "There was more confidence because currencies stabilized," says Geoffrey Wong, who heads Asian investments outside Japan for UBS Luxembourg Equity Fund Singapore. Adds Robert Auld, chief investment officer for Fidelity in Hong Kong: "The Korean and Thai governments are trying to do the right things. They needed to make changes at the policy level, and they were rewarded."

Even Singapore, whose sound fundamentals helped insulate it somewhat from regional tumult, has been making changes to appeal to foreign investors. Its market is dominated by a handful of companies that, before the crisis, were loath to share information. Now, says Kung, banks and other large companies are disclosing bad debts, loan exposures, and other data to fund managers. "It used to be so difficult to get access," Kung notes.

ROBUST YEN. Unlike East Asia's recoveries, the gains in many Japan funds puzzle some analysts. A big bank bailout and economic spending packages passed by the Diet drove "got the foreign crowd pretty excited," says Tim Kearns, a market analyst with Barclays Capital, even as domestic investors stayed out of the market. Foreign buying helped the 24 Japanese funds BUSINESS WEEK tracks record a 22.18% gain in the quarter, just a shade under the 25.73% rise achieved by the 21 other Asian funds tracked.

Chalk up some of Japan's gains, too, to the resurgent yen, whose 20% rise against the dollar in the quarter helped drive the 31.8% gain in the Frank Russell Japan Equity A Fund, for instance. Savvy stock-picking was an advantage, too, for Symon Parish, a Russell portfolio manager in London. His fund's primary focus on little-known companies with unique technologies has led him to Nidec Corp., a maker of spindle motors used in hard-disk drives. A better-known Russell pick: Toto Ltd., a maker of toilets and faucets that, like so many other Japanese outfits, has long been undervalued in the bear market.

But looking forward, there may be less reason to buy Japan. The brawny yen has rekindled worries about exports, and companies are even forecasting a profit slide of 21% for the fiscal year ending in March. Such forecasts could be revised downward as the economy plunges into its third straight year of recession.

If confidence is beginning to wane in Japan again, there's always the U.S. tech sector to spice up portfolios. Funds weighted toward makers of software and computer gear have especially thrived and account for at least 7 of the top 20 performers on the Scoreboard. All told, offshore funds investing in U.S. technology companies gained 35.52% in the quarter. The reason: brisk capital spending in the U.S. And "the capital-spending cycle still has a way to go," says Michael J. Howell, the London-based managing director of CrossBorder Capital Ltd., a global institutional investment adviser. Among the beneficiaries of the boom: J&W Seligman & Co.'s U.S. Communications & Information Fund, which climbed 42.15% in the quarter, made its numbers with such companies as Lexmark, the Kentucky-based maker of printers and peripherals. Other top-performers for the fund included Checkpoint Software and Network Associates.

In coming months, tech "investment opportunities should abound," says Storm Boswick, a managing director for the fund. But after skidding last October and then soaring, the ride could get rough again this year. Even Boswick concedes that Year 2000 technology problems could lead to wildly seesawing values in his sector.

In comparison to the tech funds' torrid returns, even the booming European fund sector looks like no more than a respectable performer. The 65 Europe funds we track climbed 16.73% in the quarter, helped by enthusiasm over the birth of the euro. But after the funds scored hefty gains through 1998, some analysts now wonder if Europe has seen its best days. "The issue with continental Europe is it's no longer cheap," says Leila Heckman, who heads global asset allocation for Salomon Smith Barney. "Companies have gotten expensive, and the economies are slowing down." Although she thinks European earnings wIll advance 12.5% this year, she also expects price-earnings multiples to drift down to about 19, from about 25 in 1998.

If Europe seems iffy to some pundits, Latin America now may be the riskiest offshore bet of all. The eight Latin funds BUSINESS WEEK tracks gained 4.45% in the quarter but were still off 40% for the year. And while investors cheered Brazil's Jan. 15 devaluation of the real and sent stocks soaring, some analysts think the region's woes will demand more unsettling reforms that could leave investors in Mexico and other Latin markets in for a rough go.

As Asia demonstrated in 1998, such complications can create opportunities--if You can spot potential reforms and jump in before the pack. In '99, the gains may shift back to Latin America. Or will U.S. tech funds continue to be the darlings of investors worldwide?

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