To make real money over the long term, you need to invest in emerging markets. But many of them are too illiquid, too opaque and too volatile to buy into directly. Here two MoneyWeek writers explain how to get in safely by the back door.
To invest in eastern Europe, buy shares in Vienna, says Andrew van Sickle
Amid all the fuss over emerging Asia, investors often forget that there's plenty of eastern promise closer to home. The former Communist countries of central and eastern Europe have been offering some of the best returns in the world for a few years now. Since the turn of the century, the benchmark Czech, Hungarian and Polish indices have risen by about 50%, 50% and 75% respectively, and last year they left developed markets - and major emerging counterparts such as Brazil and India - standing, with returns of 60% to 80%. The Baltic markets (Lithuania, Latvia and Estonia) jumped 50%, and Slovakia rose by 86%.
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And no wonder. GDP growth in Poland, Hungary, the Czech Republic, Slovakia and Slovenia is expected to come in at around 5% for 2004, while the "Baltic Tigers" have been notching up growth of 6% to 8%. This has been underpinned by widespread deregulation and structural reforms in preparation for EU entry in May 2004. This has helped bring lower inflation and interest rates, hence stimulating consumption. Western firms have rushed to cash in on the region's well-educated and cheap labour force - Polish pay levels are about 20% of the German average - and scant ownership of consumer goods. Average corporation tax rates of 21% in the ten new EU members, compared to 31.4% in the EU 15, also help explain why foreign direct investment into central and eastern Europe hit a record $67bn last year - and why iconic German carmaker Volkswagen has begun producing cars from across its entire product range in the former eastern bloc.
And the story is far from over. The region still has plenty of catching up to do - GDP per head is still just 40% of the EU average and the new entrants are gearing up for membership of the euro, which implies further falls in rates and inflation. Indeed, GDP growth rates in the East should outpace those in the West for "several decades", says Alastair Reynolds, investment director of emerging markets at Scottish Widows. Stockmarket valuations are also looking reasonable, with Hungary on an average p/e of about 11 times earnings and Poland on 13 - down from 16 a year ago amid rapid earnings growth.
But how do you cash in on this compelling long-term story? Easier said than done. Eastern European markets are small and illiquid, with just a handful of stocks accounting for most of the turnover. Funds targeting eastern Europe thus include a sizeable exposure to Russia, diluting the stake in the region. Many institutional investors are sceptical, concerned about transparency in the region and unfamiliarity with local managements. The answer then is to play the region through the western gateway to eastern Europe: Austria.
The Viennese stockmarket has blossomed over the past few years as local firms have gained a strong foothold in their neighbouring markets. Two-thirds of Austrian firms do business in the east, and are increasingly heading southeast, taking over firms in prospective EU entrants Romania and Bulgaria. No wonder that Austria's ATX index, also underpinned by privatisations and government efforts to encourage private pension provision, has risen by 34% and 56% over the past two years and is tipped to appreciate by another 10% to 15% this year. Austrian stocks, says David Dudding of Threadneedle Investments, "give you access to the only region of Europe that's growing fast".
Merrill Lynch has put together a basket of 25 western European stocks that are promising plays on the great eastern European growth story. Austrian firms make up the biggest proportion of the basket with seven stocks, but all get over 10% of their revenue or profits from eastern Europe, or gain a "significant" proportion of their overall growth from the region. Those rated neutral' are pricier than the buys', but look promising over the longer term. One favourite is Austria's Wienerberger (WBSV.VI, e35, buy), the world's biggest brick maker, which generates about 33% of its sales in the region. Packaging group Mayr-Melnhof (MMKV.VI, e127.11, buy) and Telekom Austria (TKA, e14.67, neutral), which has just snapped up the Bulgarian mobile operator Mobitel, are plays on rising consumption. Then there's Erste Bank (ERST.VI, e37.85, neutral), which boasts the region's biggest branch network and derives 50% of its revenues from the region; it has been eyeing up a purchase in Romania. Erste is being buoyed by growing consumer demand for mortgages and loans, as is its domestic rival Bank Austria (BACA.VI, e66.46, neutral).
Among other European stocks, consider Italy's Banca Intesa (BIN.MI, e3.6, buy) and Swedish bank SEB (SEB.A, e127, neutral) - the latter boasts the second-largest market share in the Baltics. Greece's Alpha Bank (ASE:ALPHA, e20.90, buy), meanwhile, is targeting the fast-growing Balkans. An alternative approach is to let a fund manager do the backdoor investing for you. The Daily Telegraph recently highlighted M&G's European and Pan European funds, which concentrate on western European companies, of which many are expanding into eastern regions. There is also a US-based exchange-traded fund covering the Austrian market, the iShares MSCI Austria (EWO), run by Barclays Global Investors.
If you want to invest in China, buy into Japan, says Euan Stuart
For most investors, nothing makes more sense than investing in China for the long term. The country is in the midst of a massive industrial revolution, with GDP expanding at double-digit rates and exports soaring, thanks to its huge, cheap and enthusiastic workforce. There may be weaknesses in the economy (a backward banking system and a speculative frenzy in a few localised property markets, for example), but long term it has to be a good bet. Will there be trouble along the way? Of course there will, but, as BusinessWeek points out, there is a precedent for thinking that this will consist of hiccups not crises. In the years after the Civil War, America's industrial output lagged far behind that of Germany and the UK. Yet from 1870 to 1914, America's economy expanded fivefold and "the US became the world's leading industrial power". Along the way there were "a handful of financial panics", but stocks still returned an average of 6.5% a year after inflation. There's no reason why that won't be the case in China too.
The question here is how to gain from the tremendous growth on offer without getting your fingers burnt. How do you play a market at such an early stage of development with few regulations protecting the buyer, little available research and a nasty habit of turning bad every few years? The simple answer is to do so through one of its major trading partners - Japan. Not only is Japan seeing a solid domestic recovery (something that makes it worth investing in anyway), but it is also the best place to take advantage of Chinese growth. Note that Japanese exports to China were up 21.3% in fiscal 2003 and in the latest fiscal 2004 figures up by another 18%.
So what should you be buying?The answer is companies that make things the Chinese can't. The last thing you want to do is invest in companies making stuff China makes too - you don't ever want to compete with them, you want to supply them with things they don't have instead. This means shipping (China hasn't nearly enough and freight rates have soared in the last years), the machinery needed to mine for raw materials and construct residential and factory buildings, and, finally, the cars and consumer goods needed to keep a growing moneyed class in Lexuses and game consoles.
In the construction equipment sector, Komatsu (code 6301) is one to look at. It is seeing demand for its construction and mining machinery recovering across the globe, yet according to Hideyuki Mizuno of Macquarie Securities, it's a good 25% cheaper than it should be. In the shipping sector, NYK and Mitsui & Co are worth a look. Otherwise, good Japan funds with exposure to the right kind of shares could be a wise investment. Barclays Stockbrokers suggests Martin Currie IF Japan, Schroder Tokyo, and Baillie Gifford Japan. Odey also offers a good Japan fund, as does hedge fund group RAB Capital.
