From the September 2008 issue of Investment Advisor • Subscribe!

Go East, Young Man!

For investors interested in diversifying their portfolios with European holdings, the best advice may be to look to the emerging markets of Eastern Europe, as opposed to the more developed economies of Western Europe.

A look at the best-performing European equity funds over the last one-, three-, and five-year periods (see tables below) show a list dominated by funds specializing in Russia and Eastern Europe.

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In fact, looking at the top five funds for each of those time periods shows the same four funds appear each and every time: ING Russia, U.S. Global Accolade Eastern Europe, Metzler/Payden European Emerging Markets, and Third Millennium Russia.

However, Eastern European markets have not been immune to the global market downturn of 2008.

After outperforming other emerging markets for much of 2008, Eastern European emerging markets have corrected sharply since commodity prices began declining a month ago, says Alec Young, international equity strategist for Standard & Poor's. "While rising incomes and credit growth are fueling strong Russian household consumption, which is supporting service and manufacturing growth, its economy remains too dependent on energy exports, in our view. In addition, slowing growth in the eurozone, a key trading partner, is also weighing on the region's equity markets."

Jan-Wim Derks, portfolio manager for ING Russia, runs a tightly-focused fund; as of its most recent report to investors, the fund had only 36 holdings. The $990-million asset fund is fully invested; cash is less than 1%. So unlike many U.S. equity fund managers who have been upping cash positions to ride out market volatility, ING Russia continues to put all of its assets to work. The top three holdings, as of mid-year, were Sberbank, the largest bank in Russia, and two energy holdings: OAO Gazprom and Lukoil.

All three of those stocks are also among the top ten holdings for Third Millennium Russia. However, the top holding is not on ING Russia's top ten list at all. It is Uralkali, a Russian company specializing in the production of potash and other fertilizers.

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