Nicholas Watson in Prague -

Considering that the winner of bne's best equity fund in the 2009 ranking managed it with a return of just 9.9%, the 78.1% return of this year's winner, the Raiffeisen-Russia-Equities fund, shows just how quick and powerful the recovery in the region's markets has been in this Year of the Tiger.

Of course, the kind of returns recorded during the period from June 30, 2009 to June 30, 2010 are mainly down to the bounce back from the catastrophic falls seen after the collapse of Lehman Brothers in the autumn of 2008, as well as a recovery in the region's economies whose strength has surprised many. "You have to take into consideration the region was very much oversold," says Peter Bodis, senior fund manager at Pioneer Investments Austria, whose PIA Eastern Europe Stock fund returned 59.6% in the period. "At the beginning of 2009, the main topic was about how Eastern Europe was going bankrupt, while the oil price was at $35, which was bad for Russia. The whole region was basically priced for bankruptcy."

This is especially true of Russia and Ukraine, which saw both their economies and markets fall heavily as the full impact from the global financial and economic meltdown hit. Russia's economy contracted by a bit less than 8% in 2009, while the main RTS index fell 75% from its peak to a low of 500 in May 2009, before recovering to finish last year at about 1400, near where it was trading at the end of June this year. Ukraine's economy was one of the hardest hit in CEE, shrinking by about 15% in 2009.

Given such falls, it's hardly a surprise that Russia and Ukraine feature heavily in this year's best-returning funds. As well as Raiffeisen Capital Management's winning fund, other Russia-focused funds that performed particularly well include the PIA Russia Stock fund (+69.1%), the DWS Russia fund (+61.3%), the Swedbank Russian Equity Fund (+55.5%) and the East Capital Russian Fund (+52.5%). And that doesn't include the hedge fund Prosperity Capital Management's three long-only Russian funds, which are classed as alternative investments and so aren't eligible to be included in the ranking: its Quest Fund was up 112.2%, its Cub Fund up 98.6% and its Russian Prosperity Fund up 88.0% in the period.

Ukraine, likewise, was a standout performer. Dragon Capital's Orange Opportunity Fund returned 61.0%, while East Capital's Bering Ukraine fund, which wasn't included in the ranking as its private equity element means it's classed as an alternative investment, returned 74.9%.

Even after last year's meteoric 129% rise in the Russian stock market, fund managers believe there is much further to go. Oil appears to have stabilised around $70 per barrel, while the Russian market is still one of the cheapest around, with global investors valuing Russian companies at an average price/earnings ratio of 8.2x, compared with India's at 17.9x and China at 15.1x.

It's no Turkey

While Russia and Ukraine are recovering from very low levels, the same cannot be said of this year's other sterling performer, Turkey, which had stood up relatively well in the face of the crisis. As the Istanbul stock Exchange headed toward setting a series of record highs during the summer, the DWS Türkei fund, this year's runner up in the equity category, posted a 72.1% return for the period, while Erste Sparinvest's ESPA Stock Istanbul came a close third with 65.6%. Last year's winner in the equity category, the East Capital Turkey Fund, put in another impressive performance, rising 47.4%.

Analysts say Turkey exhibits all the major attributes that buy-and-hold investors look for in a country: positive demographics with more than 50% of the population under 25 years old; high savings rates so it can finance growth internally, especially important given the credit crunch; and a still relatively under-invested market, meaning competition in many areas is not so stiff, providing opportunities for higher-than-normal rates of growth. In addition, Turkey benefits from its geographical position straddling Europe and the Middle East, where cultural ties have allowed it to flourish in areas such as construction and finance. Turkey is by far the largest investor in northern Iraq, where it provides about 80% of the area's food and materials in trade worth an annual $7bn.

Funds centred on the Central Asian/Caucasus region also performed well. The Swedbank Central Asia Equity Fund returned 38.4%, while Sturgeon Capital's balanced fund returned 7.30%, bringing its three-year performance to 19.24%, among the highest in its peer group. "In terms of investor appeal, Central Asia benefits broadly from the long-term story of economic convergence between emerging markets and developed markets, and more specifically from the natural resources story," says Brian O'Callaghan, CEO of Compass Asset Management.

Most funds are predominantly invested in the two regional heavyweights, Kazakhstan and Azerbaijan. O'Callaghan says Kazakhstan, in particular, stands out in the region for its vast and varied natural resources - the giant Kashagan oilfield is due to come on stream in 2012-13 - combined with a relatively stable and investor-friendly political and economic environment. "At Compass, these factors fill us with a great deal optimism for medium- and long-term investment opportunities," he says.

Clemente Cappello, CEO of Sturgeon Capital, whose Sturgeon Central Asia Fund has an exposure to Kazakhstan of around 10%, says he also likes Kazakh equities. "The market is relatively cheap, probably because it is considered riskier than other emerging markets such as Russia, but the track record in terms of governance and transparency is quite good," he says. The vast majority of the Sturgeon Central Asia Fund, some 60%, remains invested in Azerbaijan, which had one of the most resilient economies in 2009, growing 9.3%, while he has also slightly increased the fund's allocation to Georgia.

Emerged Europe

While Russia, Turkey and Kazakhstan have typically been the centres of outperformance, the more stable, less risky countries of Central Europe, namely the Czech Republic and Poland, also had an extremely good year. The Raiffeisen Czech Equities fund rose 42.8% in the year, while the ING Czech Equity fund rose 24.7%. "I understand that the Czech Republic, Poland and Hungary are not as sexy emerging markets as they used to be, but they are still quite fertile ground going forward," says Robert Bohynik, chief investment officer of ING Investment Management in the Czech Republic.

As well as being partly a leveraged play on Germany (which reassumed its position as the economic growth engine of Europe when it posted GDP growth in the second quarter of 2.2%), the funds focused on these Central European countries exhibit the positive characteristics of emerging markets such as higher GDP growth rates and still not fully developed markets for goods and services (albeit to a lesser extent than in Russia and Turkey), but without the negative political dynamics inherent in those riskier countries. "These are countries well anchored into European structures, so quite a lot of risk is off the books already," says Bohynik.

This year was also a good one for fixed-income funds. The winner was the DWS Europe Convergence Bonds, which returned an incredible 50.9%, followed by the Russia Renaissance Debt Fund and the Citadele Eastern European Bond fund both returning 30.6%, the ESPA Bond Danubia with 20.9% and Pioneer Investments' Central and Eastern Europe Bond fund with 20.3%.

Grete Strasser of Pioneer Investments says all three of the main components in bond investing were favourable during the year: domestic bond markets rose, most of emerging Europe's currencies recovered and spreads on hard-currency bonds narrowed. For example, the Czech bond market rose 12.6% during the year in local currency terms and with the currency appreciation that return rose to 17.3%, while the Russian bond market rose 22.7% and with the currency that rose to 43.8%. The spreads of Ukraine government bonds tightened 300 basis points during the year, while those of Romania tightened 143 basis points. "These three components' performance all contributed for our fund in Central and Eastern Europe and therefore we had a pretty good performance not only on a one-year basis, but on a year-to-date basis," says Strasser. "We expect further gains as long as risk appetite doesn't get any worse and the euro- and dollar-denominated yields stay at low levels through the end of year, so that there remains enough appetite for higher-yielding products like CEE bonds."

Jorgen Hartmann, fund manager for the winning DWS Europe Convergence Bonds fund, said the general strategy of the fund has been to focus on countries that are least dependent on EU growth and could benefit from the global recovery. "Such countries have been Russia and Kazakhstan, whose GDP performance is closely linked to the global oil price, and Ukraine, which is mainly a global steel exporter," he says. "Also Poland and Turkey have been over-weights in the fund, since their stronger domestic markets and lower degree of economic openness shielded them from the massive slowdown in growth of many Western European countries."

In terms of the amount of cash going into CEE funds, the fund tracker EPFR reports that unlike with most of developed market equity and bond funds, which attracted less money during the first half of 2010 than they did during the second half of 2009, emerging market equity and bond funds took in more money during the first half of 2010 than they did during the latter half of 2009. By mid-August, EPFR said emerging market bond funds had extended their year-to-date record inflows to $32.8bn, which trounced the previous full-year record inflow of $9.7bn set in 2005, while all emerging market equity funds extended their year-to-date inflows to $34.5bn. "The numbers that catch the eye for the first half of the year are the massive outflows from money market funds and the money committed to emerging markets bond and global emerging markets equity funds," observes EPFR Global senior analyst Cameron Brandt. "They suggest there's still a real desire to put the money preserved from the 2008 downturn back to work and a belief that emerging markets offer the best combination of risk and reward. Indeed, the bond flow numbers suggest a fair number of investors are giving this asset class 'safe haven' status."

And the winners are...

•bne 2010 Best Equity Fund

The Raiffeisen-Russia-Equities fund was this year's winner, returning 78.17% in the year. Angelika Millendorfer, Head of Emerging Markets Equities at Raiffeisen Capital Management, says the outperformance of the fund was very much driven by stock picking and a high exposure to small-caps (+/- 25% of net asset value), as well as strong deviations from the benchmark (50% of NAV is off benchmark). "The key to outperformance is the management team in Vienna and Moscow: Raiffeisen Capital Management's Russia experts take care of the large/mid caps, while colleagues from Raiffeisen Moscow take care of the small-cap investments," says Millendorfer. She says that Raiffeisen Capital Management never (correctly) had a default scenario for the Russian state/coporate sector and so was fully invested throughout the reporting period. Sector allocation was not a driver of outperformance with the exception of its cautious view on the oil and gas sector.

•bne 2010 Best Fixed-Income Fund

DWS Investments' DWS Europe Convergence Bonds is the standout winner in the fixed-income category this year, returning an astonishing 50.89%. Fund manager Jorgen Hartmann says the fund benefited from the good global risk sentiment, especially in the first quarter of 2010, resulting in local currencies in CEE appreciating, local yield levels falling and spreads of hard currency bonds in the region tightening substantially. In general, the strategy of the fund has been to focus on countries that are least dependent on EU growth and can benefit from the global recovery, namely Russia, Kazakhstan and Ukraine, as well as Poland and Turkey whose stronger domestic markets and lower degree of economic openness shielded them from the massive slowdown in Western Europe. "The main difference to the fund's peer group can be seen in the big underweight of CEE classic convergence countries like the Czech Republic or Hungary. Conversely, the fund has a bigger exposure to the more eastern countries with higher growth rates and higher convergence potential. Also the fund holds the bulk of its exposure via FX derivatives rather than via local currency sovereign bonds," Hartmann says.

•bne 2010 Best Real Estate Fund

Renaissance Wealth Management's Renaissance-Business-Nedvizhimost fund is this year's winner of the bne 2010 Best Real Estate Fund with a return of 21.8%. "We are very proud that our efforts in delivering strong returns to the fund's shareholders and our continuous commitment to excellence despite the tough market conditions were recognised by bne's award. With the street-retail segment being the most resistant during the current economic downturn and demonstrating highest pace of recovery at present, our initial belief in the high investment appeal of the Moscow street-retail market and our choice of specific street-retail properties for the Renaissance-Business-Nedvizhimost Fund portfolio proved to be the right investment decision," says Ekaterina Konstantinova, managing director and Head of the Real Estate Group, Renaissance Wealth Management.

•bne 2010 Best Balanced Fund

Citadele Asset Management's Citadele Eastern Europe Balanced Fund is this year's winner in the balanced fund category with a 24.3% return for the year, primarily driven by the strong performance of the hard currency debt markets of CEE during this period, which at the start of the period, July 2009, formed 85% of the fund's assets. "Following the late 2008/early 2009 panic, these debt markets offered amazing opportunities with bonds of fundamentally strong issuers offering yields in double digits. Subsequently, the market reacted very positively to the strong economic fundamentals of the region, with strong liquidity boost provided by global monetary policy stimuli provided by the world's leading central banks," says fund manager Andris Kotans. "As the Eurobond market rallied and the amount of obviously undervalued debt instruments decreased, the weight of equities in the fund was increased closer to 20% due to better forward-looking risk/return balance. Further increase of the equity weighting is expected in the coming months, yet the region's Eurobonds are still expected to form the backbone of the fund."

[[DOC:bne_092010_final,Click here to see full table of CEE/CIS funds in the bne Fund Survey 2010]]