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P S

Emerging Europe: Standout Returns But Often Overlooked

The growth in Asian and Latin American markets has been widely publicized, particularly because of their burgeoning ranks of middle-class consumers. By contrast, Europe’s developing markets have received little attention. Yet emerging Europe outperformed the global emerging markets index during much of the last decade. (See chart.)

Emerging Europe Equities Versus Global Markets Total Return Indexed to 100, From December 31, 2000, Through March 31, 2011

700

600

500

  • MSCI Emerging Markets Europe Index

  • MSCI Emerging Markets Index

  • MSCI All Country World Index

400

300

Emerging Europe was particularly hard-hit by the nancial crisis— losing 68% in 2008—only to rebound with equal velocity, returning 118% total in 2009 and 2010.

200

100

0

’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 3/11

With Russia composing over 60% of the MSCI Emerging Markets Europe Index, the index’s perfor- mance has been signicantly tied over the past decade to the heavy energy and utilities weightings within Russia’s stock market.

But Eastern Europe’s investment prospects also may hinge on the region’s continued ability to modern- ize and grow its consumption—a trend set in motion by the collapse of the Soviet Union 20 years ago.

Post-Soviet Transition

Russia and such former Eastern Bloc nations as Poland, Hungary, and the Czech Republic already have undergone “an astounding transition from communism toward capitalism,” says Leigh Innes, manager of the Emerging Europe & Mediterranean Fund.

“For example, there were only about 10 stocks we would look at in Russia about eight years ago, and today there are almost 70, as well as a strong pipeline of initial public offerings of stock,” Ms. Innes says.

However, she adds, there is still much catching up to be done.

Equity performance in Eastern Europe, emerging markets, and developed markets is represented, respectively, by the MSCI Emerging Markets Europe Index, MSCI Emerging Markets Index, and MSCI All Country World Index. Returns are in U.S. dollars.

Source: MSCI RIMES.

“Compared with Western Europe and even many other emerging markets, Eastern Europe is quite underdeveloped. Even though there have been large retailers throughout emerging economies in Asia for years, supermarkets and discount stores are actually new to Russia,” she says.

At the same time, she says, “It would be a mistake to think of Russia only as an oil and gas story.”

Ms. Innes believes that Russian consumer staples and discretionary stocks—such as X5 and Magnit supermarkets—are well positioned to capitalize on increasing economic growth and consumers with low debt and rising wages.

Nevertheless, problems persist. Russian companies continue to grapple with government interfer- ence, bureaucracy, and corruption.

The good news is that not all of Eastern Europe has governance and debt problems. “Investors shouldn’t think of this region as one mono- lithic group,” Ms. Innes says.

Poland, for example, was one of the few countries in the world to sidestep the recent recession, but its stocks are among the region’s more costly.

Such disparities can create oppor- tunities, however, for investors with greater risk appetites. Ms. Innes has been nding attractive investments in Turkey and such frontier markets as Ukraine, Kazakhstan, and Georgia.

“Volatility is no stranger to this sector, and I don’t expect that to c h a n g e , s h e s a y s . B u t t h e r e g i o n unique history and growth pros- pects create compelling long-term opportunities.” s

International investing is subject to market risk and risks associated with unfavorable currency exchange rates and political or economic uncertainty abroad. Investments in emerging markets are subject to the risk of abrupt and severe price declines. Stocks mentioned in this article made up 10.3% of the Emerging Europe & Mediterranean Fund as of March 31, 2011.

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