Offshore Funds Are on the Ropes

War, high oil prices, and SARS clobbered funds

A spike in oil prices, bombs over Baghdad, and the outbreak of a killer pneumonia bug. Headlines about those events clobbered investor confidence in the first quarter, and global money managers hoping for some good news after three years of down markets came away disappointed. Just 30 of the world's 500 biggest mutual funds managed outside of the U.S. and tracked in BusinessWeek's quarterly Offshore Funds Scorecard emerged from the first quarter with positive returns.

The period was disappointing across the globe. Some investors in the biotechnology and health-care sectors escaped the miasma, and so did investors in a handful of Asian funds. The top performer was a Hong Kong-based outfit called Value Partners A, which delivered a 12.3% return.

Hong Kong's gain was South Korea's loss. That country, Asia's hottest investment destination a year ago, had the two worst-performing funds in the first quarter. And even the best performers didn't offer much inspiration. Eighteen of the top 25 funds got there with puny gains of 2% or less. One volatile sector, biotech, stood out. Michael Sjöström, manager of the Pictet Funds Biotech fund, which gained 2.6%, says the sector has a positive long-range outlook because of aging populations in the U.S., Europe, and Japan. The market capitalization of traded biotech companies, he notes, has more than doubled, to $25 billion, since 1997.

Offshore funds are typically based in tax havens such as Luxembourg and the Isle of Man, and cannot be marketed to U.S. residents because they don't file reports with the Securities & Exchange Commission. Yet it's a vast market that represents the collective judgment of fund managers around the world. The data here come courtesy of Standard & Poor's, which, like BusinessWeek, is a division of the The McGraw-Hill Companies.

Perhaps the most surprising loser in the quarter was South Korea, which fell victim to the triple whammy of tensions with North Korea, a major accounting scandal at the nation's third-biggest conglomerate, SK Group, and concerns about a huge buildup in consumer credit. The benchmark KOSPI fell 15.2% during the quarter. "Anybody who had a large exposure to the financial sector took a bruising," says Park Kyung Min, CEO of Hangaram Investment Management Co. Fidelity Funds Korea, down 19% for the quarter and the worst-performing fund on the list, had such exposure. As of last October, 27% of its holdings were in major banks and 6.9% in SK Telecom, whose stock suffered from ties to SK Group. Fidelity declined to comment, as did fund managers at JF Korea Trust, which lost 18%.

Funds focused on nearby Japan also finished the quarter below the water-line. "Japanese exporters were hit hard by the slowdown in the U.S.," notes Barclays Capital Research Japan strategist John Richards, who thinks exports to the U.S. will contract again in the second quarter. Some big blue chips such as Mitsubishi Motors and Honda, however, are enjoying brisk growth in Europe, notes HSBC Securities analyst Christopher Richier, who rates both stocks a buy.

A more attractive bet is China -- for investors who can stand the risk. Ayaz Ebrahim, chief investment officer for HSBC Asset Management (Hong Kong) Ltd., likes consumer-oriented companies "on the back of continued strong domestic consumption." HSBC's GIF Chinese equity fund, which racked up 6.2% growth, benefited from its core holdings in transport companies such as Zhejiang Expressway and Costco Pacific. It also holds big stakes in oil and gas concerns such as China Petroleum & Chemical Corp.

Outside China, the pickings get very slim. But some specialty technology and regional funds did manage microscopic gains. Things might be finally looking up for tech stocks, says Stuart O'Gorman, a fund manager with the Henderson HF G1 Technology fund, up 1.3% for the quarter but down 37% over a year. Why? "Technology is doing well because it had the hell beaten out of it," he says bluntly. O'Gorman thinks there are gems out there that have steady cash flows and attractive valuations. One is Alameda (Calif.)-based UT Starcom, a wireless service purveyor with a big position in China, trading at 15 times earnings. Another is Fremont (Calif.)-based Lexar Media Inc., which makes film for digital cameras.

In biotech, a highflier is Foster City (Calif.)-based Gilead Sciences Inc., which makes a popular HIV-related drug called Viread, and whose stock hit a 52-week high in early April. "It was one of the best performers in the last quarter -- indeed, in the last year," notes Pictet Biotech's Sjöström. He's also fond of CuraGen, a genomics-focused drug company, and antibody drug specialists such as Abgenics and Medarex.

Another Pictet Fund, focusing on Eastern Europe, showed up on the top 25 list, albeit with a gain of less than 1%. Fund manager Jack Arnoff thinks there are more gains ahead as big European institutional investors discover the region. The fund has loaded up on such players as the Czech Republic's Komercni Banka and Polish Telecom. Arnoff is also keen on some Russian companies, including power generator UES and energy outfits such as Gazprom. Contrary to Russia's Wild East image, Arnoff argues the country's regulatory oversight is improving and its business practices are converging with those of the West. "Russia is an extremely positive story," he says.

Well, for global investors, positive stories are hard to find. Although things are settling down in Iraq, that didn't stop the International Monetary Fund from recently slashing its 2003 world growth forecast to 3.2%, from 3.7%. So the outlook for investors will continue to be uncertain. Still, if the months ahead bring fewer alarming headlines, that will be a step in the right direction.

By Brian Bremner in Tokyo, with David Fairlamb in Frankfurt and Moon Ihlwan in Seoul

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