Unloved, unowned but undervalued: Emerging Europe shakes off its past

SANDWICHED between the bright stars of emerging Asia and the fading light of the West lies Eastern Europe, an investment destination that is often forgotten and perennially unfashionable. This is partly because the region has struggled to shake off its Soviet legacy – at least in the minds of Western investors it is still tainted with corruption while the tentacles of a big state strangle free markets and business. More recently, it suffered unfairly as a result of its perceived ties to the Club Med countries.

But here perception lags far behind reality; the region is recovering well from the recent financial crisis and countries are gradually rolling back the role of the state. When everybody is focusing on the negatives and ignoring the positives, that is precisely the time that the savvy investor should be buying. Fund managers are already quietly becoming more bullish about the region’s prospects but valuations remain compelling.

“It is a very cheap market on the basis of valuations. Only four years ago emerging Europe was trading at a premium to global emerging markets on a price-to-earnings (p/e) basis,” says David Reid, an analyst at BlackRock’s Eastern European Investment Trust. Russia is currently trading at a price of seven times earnings while Turkey is on 10 times and Poland is on 11-12 times.

While fund managers are keen to stress the heterogeneity of the region, “one common feature that they have, and it’s probably the most important one for investors these days, is that they offer growth and yield,” says Renaissance Asset Managers’ Karol Chrystowski. Investors are desperately seeking yield at the moment as a source of income.

Although cheap valuations are a good enough reason in themselves to be bullish, there is more to emerging Europe than value. It also offers the capacity to tap into some of the biggest investment themes of the 21st century.


First, the region’s biggest market Russia is inextricably tied to the fortunes of growth in emerging markets. Its trade turnover surged 1,200 per cent between 1998 and 2008 with exports to China rising 10-fold over the past decade, according to Robin Geffen, chief executive of Neptune Investment Management and fund manager of its Russia and Greater Russia fund.

Second, emerging Europe is placed for accelerated catch-up growth with developed markets. A youthful and expanding middle-class is forecast to support consumption. For example: “In Turkey we have a consumer heaven with some of the best demographics in the world, a huge number of small and mid-size businesses, generations of business tradition, hardly any penetration on mortgages and exceptional financial institutions,” says Chrystowski.

Turkey is not alone. In Russia, household debt is low with very few mortgages because most house purchases are done using cash. Year-on-year wage growth combined with a low basic income tax has improved disposable income and seen Russia grow to become one of Europe’s largest retail markets.

Thirdly, Eastern Europe is also a leveraged play on the industrial success of Germany, which now outsources much of its manufacturing to Central Europe. Around 70 per cent of flat screen televisions sold in Europe come from Poland while Poland is also the second largest supplier to Ikea after China, says Chrystowski. The region is also becoming a hub for accounting centres of multinationals such as IBM and Royal Dutch Shell.

Although there is usually a heavy weighting to Russia in funds – partly because the typical benchmark MSCI Emerging Europe 10/40 is 65 per cent weighted towards it – fund managers are keen to spread their risk: “Having a regional fund enables you to have a more multi-dimensional risk positioning. Within Russia the correlations between many companies are actually very high but if you look at it on a pan-emerging Europe basis, you end up with a much healthier correlation matrix,” says BlackRock’s David Reid.

With valuations attractive and the fundamentals compelling, it’s time to make the most of the Eastern European story before the masses cotton on and the region becomes expensive.


According to data from Morningstar, there are 36 Emerging Europe equity funds with a track record of at least three years that are available to UK investors. There are also six funds which focus on Russian and Commonwealth of Independent States (CIS) equities, which are not included in the above table. Many of these are structured as a Sicav rather than as an OEIC – the above table doesn’t include investment trusts. The average three-year performance is -10.35 per cent while the average portfolio size is £251.25m. Figures are calculated on a bid-bid, gross income reinvested basis.