International Equity Funds -- Year-End 2002 Review

Few Spared in Global Meltdown

Jan. 9, 2003 -- Given that the U.S. stock markets suffered their third consecutive year in the red -- the worst such streak since the late 1930s -- it might not be surprising to find that markets around the globe have almost uniformly endured losses.

A cursory scan of the Morgan Stanley international equity indexes reveals that developed markets around the globe sustained heavy losses in 2002. Declines generally ranged from 10% to nearly 40%, continuing last year's trend. The emerging markets, with a few exceptions, also incurred big losses for the year.

The average international equity fund dropped 14.6% in 2002, according to data from Standard & Poor's. The average U.S. stock fund, in comparison, fell 23%, despite a late year-end rally. Among global equity funds -- those that have the latitude to invest in both U.S. and international stocks -- the climate was also grim. The average global equity fund dropped 18.7% in 2002.

William Fries, lead portfolio manager of Thornburg International Value Fund (TGVAX), noted that when it came to foreign markets, 2002 was pretty much a repeat of 2001. "The main difference was that 2002 was a little worse for the developing markets than 2001 because of continued weakness in the U.S. economy," he said.

Fries points to South Korea and Taiwan, which primarily serve the U.S. technology sector, as an example: "Coming into '02, there was some optimism that American high tech would rebound, but that never happened, and consequently some Korean and Taiwanese companies, particularly in the semiconductor industry, were hurt."

Russia and Eastern Europe Continue to Shine

Two bright spots in the global economy in 2002 were Russia and Eastern Europe, where four out of five of the year's best-performing international equity funds were focused. These relatively small and obscure markets delivered yet a second strong year.

Fries believes that while the Russian markets are heavily dependent on oil prices -- which remain high -- the economy's success can no longer be considered a fluke. "There's no question that the Russian markets are gradually becoming more viable and orderly," he commented. "Russia and Eastern Europe are delivering faster growth than either Western Europe or the U.S., and I think this trend will continue at least through the next year."

Kurt Umbarger, a portfolio specialist with T. Rowe Price, notes that we are seeing reforms and restructuring in Russia, which are "positive for equities long-term." He points out that Russia has been privatizing various companies, including its large state-owned oil firms. "Russian firms are becoming more fiscally responsible; they've made significant strides in just a few years since the ruble was devalued and Russia defaulted on its debt," he added.

However, there are risks inherent with investing in Russia, as well as Eastern Europe and Turkey. "For one thing, Russia does not have a very diverse market, it remains heavily dependent upon its energy sector," Umbarger said. But he also noted that Russian oil stocks are "highly undervalued relative to their global peers." The second best international equity performer, the $83-million ING Russia Fund (LETRX), in fact has about half of its assets in oil and gas producers. Nearly 40% of the fund is represented by just two Russian energy concerns: Yukos and Lukoil.

When it comes to Eastern Europe, several countries are on the verge of joining the European Union, beginning in 2004. "This is a major secular trend that is driving the equity markets there upwards, particularly in Hungary, Poland and Czech Republic," Umbarger noted.

Western Europe: Malaise in Germany

Western Europe, dominated by the Euro-Zone countries, stomached another weak year in 2002. Economic difficulties on the continent appear to be deepening, particularly in Germany, which is on the brink of a potential recession. This is particularly troubling, considering that Germany accounts for nearly one-fifth of Europe's total GDP.

"Governments and labor unions in Western Europe are going to have to recognize that they have to change their employment structure and become more efficient and allow their companies to become profitable entities," Fries said.

Looking ahead to 2003, Fries noted the health of the U.S. economy is of paramount importance to Europe. "The weakening dollar will make things more difficult for European exporters," he said. Umbarger sees "lackluster GDP growth" in Europe in 2002; perhaps between 1.5%-2% across the continent as a whole. "However, given that most European equities have compressed in valuations, that should attract stock buyers, which should benefit the markets."

One industry in Europe that Umbarger is particularly optimistic about is wireless telecom. "European telcos have been in a very tough environment over the past two years," he said. "But they've been doing the right things by cutting capital expenditures and consolidating their operations, i.e., exiting certain unpromising wireless markets. This should help pricing and corporate profitability going into 2003. Moreover, valuations in wireless are becoming very attractive."

Asia: South Korean Tiger Still Has Bite

Another bright spot for equity performance was in South Korea. "In 2002, they had GDP growth of about 6.5%, but there are concerns that growth will slow down a bit in '03 ," Umbarger said. "Still, from a global context, Korea remains an attractive place to invest," he said. "For example, electronics giant Samsung, which has performed very well, is still only trading at about 8 times forward P/E."

Umbarger also noted that "Korea, as well as Taiwan, would be the principal beneficiaries of a potential rebound in the U.S. tech sector, although domestic consumption in these countries remain pretty robust." One dark cloud that has recently gathered over South Korea, however, is the tense nuclear stand-off with North Korea.

In larger Asia, Fries says he thinks that the huge untapped Chinese markets will drive growth in the global telecommunications industry, leading to a possible recovery in that long-battered sector. "Infrastructure in China is rapidly developing, with respect to cellphones, cellular phones, personal computers," he said.

INTERNATIONAL EQUITY FUNDS Best Performers2002 Returns (%)Worst Performers2002 Returns (%)

US Global Accolade Fds:Regent Eastern Euro (EUROX) +34.7AMIDEX 35 Mutual Fund (AMDEX) -39.9

ING Russia Fund (LETRX) [formerly called Pilgrim Troika Dialog Russia Fund]+24.7INVESCO European Fund (IEUCX) -33.8

Commonwealth:New Zealand Fund (CNZLX) +21.6Smith Barney International Aggressive Grth/A (CSQAX) -31.8

Vontobel Eastern European Equity Fund (VEEEX) +21.4Eaton Vance Tax Managed International Grth/C (ECIGX) -31.4

Third Millennium Russia Fund (TMRFX) +19.7TCW Galileo European Equity Fund/I (TGEEX) -31.2

GLOBAL EQUITY FUNDS Best Performers2002 Returns (%)Worst Performers2002 Returns (%)

Prudent Bear Safe Harbor Fund (PSAFX) +29.5Dessauer Global Equity Fund (DGLEX) -45.0

First Eagle SoGen Global Fund (SGIIX) +10.5Credit Suisse Global Post Venture Capital/A (CPVAX) -35.1

M Stanley Inst:Global Fran/A (MSFAX)+8.1Smith Barney Premier Selections Glbl Growth/B (SPGGX) -34.8

Van Kampen Tax Managed Global Franchise (VGFAX) +6.6Seligman Global Growth Fund/A (SHGOX) -31.5

Polaris:Global Value Fund/Investor (PGVFX) +3.8Dreyfus Founders Funds:Worldwide Growth/T (FWWTX) -31.2

Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Data as of 12/31/02.

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