Emerging countries often appeal to investors’ imagination. Fast-growing economies, demographic attractiveness and a wide variety of investment opportunities make them attractive. In this week’s Top 5, we look at the best equity funds for emerging Europe.
The vibrant economies of South-East Asia are prominently on investors’ radar, partly due to China’s spectacular economic rise, which has given the entire region a major economic boost. As a result, the emerging countries that lie less far to the east, the Central and Eastern European region, have been forgotten.
Emerging countries are not a homogeneous group, but rather a collection of countries at different stages of development where there can be large differences in socio-demographic, fiscal-economic policy and political stability. That is also reflected in the complicated history of the countries in this region.
The easternmost European countries, including Ukraine, Moldova and the Baltic States, as former parts of the Soviet Union, have been strongly associated with the communist, Russian-style planned economy. Former Soviet satellite states such as Poland, Hungary and the former Czechoslovakia also spent a long time under the Russian regime’s sphere of influence. The Cold War, the economic alliance Comecon and the military Warsaw Pact created an East European bloc with the Iron Curtain as its physical separation from the West.
Development overlooked
After the collapse of the Soviet Union in 1991 and the autonomous status of the Eastern European countries, many states sought affiliation with the West by becoming members of what is now the European Union and by joining Nato. The difference in economic development of the countries after they became independent is reflected in the country classification by index compilers.
MSCI classifies Estonia, Romania and Slovenia as Frontier Markets, for example, while the Czech Republic, Hungary and Poland are one step higher and are classified as Emerging Markets. The latter country was the first former Soviet satellite state to be promoted to the Developed Markets group by rival Russell FTSE in 2018.
Despite the development that Eastern Bloc countries have experienced over the past 30 years, they are still often overlooked by investors and equity analysts. Perhaps Eastern European markets have never really been discovered by investors.
Emerging Europe assets down sharply
The latter is also reflected in the development of assets under management and fund flows into the Morningstar Emerging Europe equity category. The category peaked in 2011 when around 36 billion euro was invested in funds specialised in Central and Eastern Europe, but assets under management have since declined rapidly, fluctuating between 10 and 15 billion euro since the end of 2014.
Over the past ten calendar years, fund flows in this category have been marginally positive in only two years. And that was before Russia invaded Ukraine in February. Since then, assets under management have fallen sharply, leaving two billion euro under management at the end of April.
Funds targeting the region had an allocation to Russian equities of around 54 percent at the end of January, while the country accounted for almost two-thirds of the MSCI EM Europe. The MSCI EM Europe index has lost more than 70 percent year-to-date.
Now that Russian shares have been removed from the index and trading in these shares is not possible, many funds in the category have suspended trading in fund units and determined the net asset value of these units. Whether the situation will ultimately lead to the closure of Eastern European investment funds remains to be seen, but it is inevitable that the war will leave deep scars on these funds as well.
Schroder ISF Emerging Europe takes top spot
Due to the major impact of the Ukraine-Russia war and the fact that many funds in the Morningstar Emerging Europe Equity category are currently not tradable and have no current price, the top five are based on the three-year annualised return at the end of January 2022.
The best-performing fund to date is Schroder ISF Emerging Europe, which posted an annualised return of 9.8 percent. The fund, which has been led by Rollo Roscow and Mohsin Memon since 2014, has long been among the best-performing funds in its category.
Over the past three years, it has beaten 82 percent of its competitors and, over the past five and ten years, 98 percent of its category peers. Especially the stock selection within financials added a lot of value, with OTP Bank, Halyk Savings Bank of Kazakhstan and PKO Bank Polski among the standouts. The selection within the energy sector was also effective, although it included many Russian names which raise questions about their current intrinsic value.
Templeton Eastern Europe Fund second
In second place is Templeton Eastern Europe Fund, with a three-year annualised return of 9.7 percent at the end of January 2022. Krzysztof Musialik has been at the helm of one of the funds where legendary emerging market investor Mark Mobius has had a finger in the pie since July 2021.
The fund has a slightly stronger bias towards lower market capitalisations versus category peers, but that has brought it something extra. For this fund too, the financial sector proved the main source of outperformance. PKO Bank Polski, Bank of Georgia Group and Sberbank of Russia, among others, were among the portfolio leaders.
Jeffrey Schumacher is director of research at Morningstar. Morningstar analyzes and rates mutual funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five investment funds or providers each week.
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