The new emerging market

The Berlin Wall fell in 1989 but this was not the sign that Eastern European economies were heading for a sudden revival.

In fact, it took another 10 years before countries such as Poland, the Czech Republic and Bulgaria shook off the Communist ways of doing business and became economies based on capitalism.

Today in Eastern Europe, the economies are growing and opportunities are there for investors.

QWL has launched a fund investing in Eastern European companies and argues the emerging market track record is better than Asia, the darling of the asset class.

According to the fund manager, the QWL Euro III Fund has delivered one-year net returns of 42.1 per cent and five-year returns of 302.5 per cent.

However, it has to be remembered that Eastern Europe was coming off a very low base after the collapse of Communism and state-run enterprises.

QWL chief executive officer Ross Hopkins said the fact that many Eastern European countries have joined the European Union has meant they are poised for growth.

“Many Western European companies are now using Eastern Europe plants for manufacturing due to the lower cost base,” he said.

“This means the west is pumping money into Eastern European economies, which is creating greater wealth for the population.”

In the Czech Republic, gross domestic product (GDP) is expected to grow by 70 per cent during 2007, while in Slovenia it will exceed 80 per cent.

Other Eastern European countries are all predicting GDP growth in double digits, with none below 20 per cent.

“These are not boom-bust economies as they are developing in a different way to other emerging markets such as Asia,” Hopkins said.

“These are converging economies, converging with the established EU economies such as France and Germany, which is why it is long-term growth.”

He said it has been a 15 to 20-year story, which is continuing as Eastern Europe creates new economies based on discretionary consumer spending and the emergence of a new banking system.

“What is happening is the banks in these countries are getting organised to deliver consumer credit products such as mortgages and credit cards,” Hopkins said.

“What we take for granted in the west is just happening in Eastern Europe.”

The new QWL fund will invest mainly in second tier companies in the Baltic States, Russia, Central and Eastern Europe.

Hopkins said Russia as an investment market is misunderstood by Australian investors, who believe nothing has changed since Glasnost in the 80s.

“Russia has taken 25 per cent of oil revenues and put it into infrastructure,” he said.

“This means they are building roads and bridges without having to borrow the money and it is creating a lot of business for local companies.”

Hopkins said next year Russia will join the World Trade Organisation, and this is expected to trigger further growth in the Russian economy.

“We have invested in traditional stocks such as Gazprom, but we are more heavily investing in companies that offer support services to the major companies.”

He said these companies are often overlooked by fund managers operating outside the region.

QWL has appointed Swedish financial group SEB Ühispanga Fondid, which has offices throughout the region.

Hopkins said this is the first Eastern European fund offered to sophisticated investors and is serviced by an asset consultant that works in the area.

And he is bullish on the outlook for the region.

“Economic growth in Eastern Europe is expected to significantly exceed that of the older EU member states in the coming years,” Hopkins said.

“As a consequence, many analysts rank the region after China for predicted stock market growth in 2007.”

ING Investment Management director of emerging markets equities Jan Wim Derks said the main attraction in the region was Russia.

“Russia’s economy and its stock market are both dominated by oil, although the relative importance of other sectors is gradually improving,” he said.

“The high global oil price has put the country in a very good macroeconomic position.”

Outside Russia, Wim Derks said the rest of the market is small for major investors such as ING.

“The only markets with some size and liquidity are Poland, Hungary and the Czech Republic, and even these three combined are smaller than South Africa or Mexico,” he said.

“The Baltic States, Bulgaria and Romania are too illiquid for institutional investors such as ING.”

However, Wim Derks said there were still attractive investment opportunities in some eastern European companies such as CEZ, a Czech Republic electrical company and OTP, a Hungarian bank that’s benefited from growing consumer demand.

“Strong GDP growth in Eastern Europe will probably last for a few more years, since these economies are gradually catching up with Western Europe in terms of productivity per capita,” he said.