Jack Arnoff of Pictet Eastern European Fund

ARNOFF: A few years ago, it was possible to trade countries as opposed to stocks, but that approach has become more outdated. For example, in Central Eastern Europe, stock performance is driven much more by company-specific stories than by top-down factors. Even in Russia, which has a very specific macro profile, there are sharp differences between the performance of certain stocks or certain sectors, such as oil stocks versus utility stocks.

S&P: How important are differences among countries in terms of financial regulation or corporate disclosure?

ARNOFF: That’s a bit of an issue of the past. At present, we have fairly transparent markets with very appropriate corporate disclosure. Most of the main companies — the top 70% of our investment universe — report their results in accordance with Generally Accepted Accounting Principles (GAAP) or international accounting standards. Our main issues with these countries are their macro parameters, such as interest rates, currencies, etc.

S&P: Do you hedge currencies?

ARNOFF: No, because we feel the markets basically discount the behaviors of their currencies. Also, our valuation methodology considers currency movements.

S&P: What are your largest country allocations?

ARNOFF: Russia, which has performed very well (48.7%); Turkey (11%); the Czech Republic (9.2%); Poland (almost 7%); and Hungary (6.2%). Russia offers the largest market capitalization in our universe and is undergoing tremendous restructuring. We’ve been concentrated in Russia for some time, and its prospects remain very positive, although its market has gotten a little bit ahead of itself.

S&P: Russia had a big run-up a few years ago only to fall sharply. Do you think that could happen again?

ARNOFF: No, there is a major difference between Russia then and Russia now. The Putin administration has established a very consistent reform record for the last two-and-a-half years. They’ve promised and they’ve delivered. Also, there was a lot of hot money in Russia in 1998, particularly in the domestic debt markets, but now, Russia isn’t leveraged at all. It’s running huge current account surpluses — the highest in its history. The equity market in Russia is the only one there to run ahead, but valuations are still attractive relative to other emerging markets and much cheaper than the developed markets.

S&P: The Russian economy has been a big beneficiary of high oil prices. How would lower prices impact your Russian positions?

ARNOFF: It would affect the Russian markets to a certain extent, but Russia is becoming much less of an oil story because of the recovery of its domestic economy. Also the government has followed very prudent fiscal policies. In this year’s budget, they’ve planned for oil prices at $18 per barrel, but they’ve been running well above that.

S&P: Is Russia, the only country where you’re overweighted?

ARNOFF: Yes, we could take some profits, but Russia continues to be a very positive story. We’re not very overweighted compared with our benchmark — the FTSE East Europe Turkey Index — because it’s a little distorted, since three Russian oil stocks make up 30% of the index. We’re limited to a 10% position in any one stock, so we’re technically a little underweight in Russia versus the index. We’ve been overweight in Russia relative to the rest of the universe since the beginning of last year.

S&P: The fund has had very strong performance in the past, but this year you’re behind. What factors are at work here?

ARNOFF: We’ve consistently outperformed the index for the last several years, but we’ve been flat compared with the index because the index’s bias toward oil companies.

S&P: For what type of investor is this fund best suited?

ARNOFF: The fund offers a good opportunity for investors to capitalize on the convergence of Eastern Europe with the European Union. Investors can also benefit from the turnaround in Russia and an improvement in Turkey. I can also recommend the fund for people who want to trade in and out on a six- to twelve-months basis since East European markets move up and down very sharply.

S&P: You mention the convergence story for Eastern Europe, but you’re underweight in those countries — such as Poland, Hungry, and the Czech Republic — most likely to join the EU.

ARNOFF: We’ve focused on Russia because we’ve been trying to take advantage of it rising from a much lower level. The convergence story in Eastern Europe is not a three- to six-month story — it’s going to unfold over the next six to seven years.