Offshore Funds: Catching the Wind

More than 90% racked up gains in the fourth quarter, but Japan funds took a nasty pounding

The war in Afghanistan, the collapse of Enron Corp. (ENE ), and Argentina's currency crisis. The final quarter of 2001 certainly didn't lack for drama. So it wouldn't be surprising if global investors took a royal thrashing. Not so, it turns out. More than 90% of the world's 500 biggest money funds outside the U.S. locked in gains during the period.

Of course, one strong quarter does not a global rally make. Many funds are still way down on a year-to-year basis. But there were some surprising bright spots. Sixteen of the top 25 funds in BusinessWeek's quarterly Offshore Fund Scorecard were focused on technology stocks in the U.S. and abroad. A clutch of Central and Eastern European funds also made a strong showing, delivering returns ranging from 25% to 37%. In addition, Asian funds, with the glaring exception of those concentrating on Japan, did well.

Offshore funds, which are typically based in countries that are tax havens, are not permitted to market to U.S. residents because the Securities & Exchange Commission doesn't regulate them and because they don't file reports with the SEC. But they are representative of a huge market that reflects the collective judgment of global fund managers as well as that of big-time U.S. institutional and retail investors. This survey, drawing on data from Standard & Poor's Micropal (which, like BusinessWeek, is a unit of The McGraw-Hill Companies) tracks the performance in dollar terms of the biggest offshore funds. (A complete list is available at

Cast an eye over the list, and you'll see signs of life once more in the land of technology. Although most tech stocks posted double-digit losses for the entire year, a strong bounceback in the final quarter may be sending a signal that the global bloodbath in tech valuations is almost over. T. Gary Liberman, manager of the J.P. Morgan Fleming U.S. Technology Fund, which topped all comers with a 64% return in the quarter, points out that 2001 saw the sharpest decline in information-technology spending since 1974. That's why his fund was off 61% on the year.

Yet Liberman thinks that info-tech spending, which is heavily reliant on big corporate customers, will gradually recover as the impact of interest-rate cuts by central banks worldwide, including 11 by the U.S. Federal Reserve, start to kick in. Jay Nakahara, manager of the $750 million Invesco GT Technology Fund, agrees. He started buying stock aggressively during the market's sharp plummet in September and likes blue-chip players such as Dell Computer Corp., as well as certain specialists in network security and data storage. He doesn't expect a boffo year and doesn't see a full-blown economic recovery taking shape until the second half. Even so, "in tech, if you wait you're too late," he says.

One of the more noteworthy trends is the growing enthusiasm among investors for Central and Eastern European stocks. The reason, figures Alain Bourrier, a fund manager at Merrill Lynch Investment Managers Ltd., is that 10 or more countries in the region are moving closer to joining the European Union, with the first ones expected to enter in 2005. They will benefit from more direct investment, better business practices, and improved productivity.

If those nations also join European Monetary Union and adopt the euro as their currency, that will again boost cross-border investment and trade. "The equity markets of Central Europe will benefit, just as Spain's and Portugal's did when they were preparing for monetary union in the late 1990s," says Bourrier. Indeed, their re-rating might already be under way as the region's stocks managed to jump 11.9% last year, while global stocks fell 16.5% overall, according to Morgan Stanley Capital International Inc. The top performer in the region was Mercury ST Emerging Europe A, up 37.2%, followed by the Pioneer Eastern Europe Equity E Fund, with a 32.8% rise, and the Schröder Eastern European Fund, at 32.2%.

One big turnaround story was Russia, where energy stocks such as Gazprom and Lukoil turned in double-digit gains. Although Russia faces plenty of economic challenges ahead, Edward Cole, an equity strategy analyst in Austrian bank RZB's London office, thinks that, in investors' minds, Russia has finally "buried the demons associated with the default and devaluation" in 1998.

Elsewhere, Pacific Rim funds outside Japan were second only to the tech funds in performance, increasing 31% as a group. One of the best of these was the $250 million Schröder ISF Pacific Equity Fund, managed by Leong Wah Kheong in Hong Kong. His top 10 holdings include Samsung Electronics Co. (SSNLF ) and United Microelectronics Corp. (UMC ) Big fourth-quarter rallies in South Korea and Taiwan helped vault his fund up 34.2%. Although Kheong is a long-term optimist, he warns that Asian markets "will trade in a tighter range in the first quarter," thanks to the still-weak global economy.

On the flip side, all but two of the worst 25 funds of the past quarter were Japan-focused. These sorry cases gave global investors 4%-to-12% haircuts for the quarter and 20%-to-35% losses for the year. And with Japan's economy still languishing in the grip of recession, deflation, and possibly a looming banking crisis, investors can probably look forward to yet another year of living dangerously.

Overall, however, there is good news for the future. Global technology stocks may have hit their bottom, Central Europe looks like a winning proposition, and most offshore portfolio managers think that a U.S. economic recovery, albeit a weak one, is in the cards for the second half of the year. With any luck, 2002 will be a period of global-market healing after the bumps and bruises of last year.

By Brian Bremner in Tokyo and David Fairlamb in Frankfurt, with Brian Hindo in New York

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