International Equity Funds -- First Quarter 2003 R

A Sinking Feeling Abroad

April 3, 2003 -- Uncertainty and anxiety over the war in Iraq have cast a black cloud over global markets while any recovery in the all-important U.S. economy has seemingly been postponed.

Mutual funds that invest overseas have incurred widespread losses. The average international equity portfolio sank 7.6% in the first quarter of 2003. Despite a handful of exceptions, stock markets around the world are in the red.

"The war is clearly a psychological negative on investor sentiment," said William Fries, lead portfolio manager of Thornburg International Value Fund (TGVAX). "But we were in a slow-growth climate long before the war."

Global equity funds, which also have the latitude to invest in U.S. stocks, dropped 5.7% in the first quarter. Here in the U.S., the NASDAQ edged up 0.42%, while the S&P 500 slipped 3.3%. In short, diversifying in foreign markets did little to help investors this quarter.

Korean Tiger Declawed

One of the strongest economies over the past few years, South Korea has now turned sour, due largely to the escalating nuclear standoff with its Communist neighbor, North Korea. The engine of the South Korean economy, the high tech sector, has been battered by weaker forecasts for exports to Europe and North America, sending equity prices plunging.

The two very worst performing international equity funds, the Matthews Korea Fund (MAKOX) and Fidelity Advisor Korea/C (FAKCX), invest exclusively in South Korea. Though most observers believe the South Korean market has already discounted the political crisis, the real problem facing the country is a softening export economy and corporate governance.

"Fundamentals are weakening in South Korea, and the markets are starting to recognize that," said Michael Reynal, co-manager of Principal International Emerging Markets/A (PRIAX). "Korea is also facing some corporate governance issues. For example, South Korea's SK Global just had to restate their earnings. This came as a big negative surprise. Now, we are seeing similar negative surprises from other companies, especially the banking sector."

China Remains Resilient

One sweet spot in an otherwise sour global economy is China. The sleeping giant is enjoying surging exports, increased industrial production, powerful domestic demand for imports, and a rapidly developing telecommunications industry. Two of the top five funds in the first quarter tracked by Standard & Poor's invest primarily in stocks of Chinese companies.

"We are seeing an investment-driven economic boom in China, which includes a very strong export component," Reynal said. "Exports from China will likely slow down this year, but that is due to a secular shift as they have gained market share from other Asian and non-Asian exporters," he added. "One of the great things we have seen in Asia in the last five years is a larger local component to economic growth -- the Asian consumer has become strong and more confident, thus allowing us to invest in their local economies."

Still, one must exercise caution when considering investing in China. "Although their internal boom should continue," Reynal said, "there is some fear that China could suffer a financial crisis in the next year or two because of debt at the government level -- both provincial and central -- over-investment, rising deficits, and global trade issues."

Europe Looks East

Although Eastern Europe and Russia remain largely ignored by U.S. investors, stocks in these countries continued to show impressive strength in the first quarter. Two of the top performing funds were invested in Russia. "This has been going on too long to be considered a fluke," Fries noted. "Eastern Europe and Russia should continue to show strong growth. They are dramatically less vulnerable to a weakening U.S. economy than Western Europe."

In fact, markets in Western Europe have generally followed the U.S. downwards, in some cases performing even worse. The major indices of Germany and France have each declined about 20% in the first quarter, while Britain's FTSE index slid almost 10%.

"The outbreak of war in Iraq has negatively impacted European markets, but they were already looking at a lackluster economic picture, particularly Germany, which is on the brink of a recession," said Kurt Umbarger, a portfolio specialist with T. Rowe Price. He added that many European banks and insurance companies have been selling their equity holdings in order to keep their capitalization ratios healthy, which has further dampened European equity markets.

War Time Strategies

Len Racioppo, president of Jarislowsky Fraser Ltd., which oversees the Fremont Mutual Fds:International Growth Fund (FIGFX), confirmed that the war in Iraq has hurt consumer confidence, but said that even before the war began he had over-weighted in industries that do well in slow-growth, recessionary environments, like foods, pharmaceuticals, and other non-cyclicals.

"We've also been trimming such areas as technology and telecom, which will suffer from economic slowdown, " Racioppo noted further. "The war has simply reinforced our strategy."

Lauretta Reeves, portfolio manager of Hansberger International Value Fund (HINTX), said she is avoiding high-risk companies with serious questions about their near-term "earnings visibility" in this environment. "We would also avoid companies which are carrying high-debt loads," she added. "In a slower economy, they would have trouble covering their interest payments."

INTERNATIONAL EQUITY FUNDS

Best PerformersFirst Quarter 2003 Returns (%)Worst PerformersFirst Quarter 2003 Returns (%)

  • DFA Invest Grp Japanese Small Company Port (DFJSX) +8.2%Fidelity Advisor Korea/C (FAKCX) -20.2%
  • ING Russia Fund (LETRX) [formerly Pilgrim Troika Dialog Russia Fund]+6.5%Matthews Korea Fund (MAKOX) -19.0%
  • Dreyfus Premier Greater China Fund/R (DPCRX) +5.5%Janus Adviser:International Value/I (JADVX) -16.1%
  • Investec Mainland China Fund (ICHNX) +5.2%Touchstone International Equity Fund/A (TIEAX) -15.8%
  • Third Millennium Russia Fund (TMRFX) +4.9%Oppenheimer Europe/C (OEFCX)-15.1%

GLOBAL EQUITY FUNDS

Best PerformersFirst Quarter 2003 Returns (%)Worst PerformersFirst Quarter 2003 Returns (%)

  • RS Investment Trust:Contrarian Fund/A (RSCOX) +6.8%Janus Aspen Srs:International Vl/Service -12.8%
  • Prudent Bear Safe Harbor Fund (PSAFX) +0.4%Janus Global Value Fund (JGVAX) -10.4%
  • GMO Tr:World Balanced Allocation (GMWAX) -1.1%Van Kampen Global Value Equity/B (MGEBX) -10.0%
  • AXP Global Series:Global Balanced Fund/Y (AGBYX) -1.4%Morgan Stanley Instl:Global Value Equity/B (MIGEX) -9.6%
  • Phoenix-Oakhurst:Managed Assets Fund/A (PZMAX) -1.6%Federated Global Value Fund/B (WUFBX) -8.9%

Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Data as of 3/31/03.

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