International & Global Equity Funds -- Mid-Year 20

July 2, 2003 — Since the end of the war in Iraq in early April, equities worldwide have rebounded, making the second quarter of 2003 a winner for global stocks coming off a very poor first quarter.

Indeed, since the March 12 market low, which coincided with the outbreak of war, major U.S. stock indexes delivered impressive gains: The S&P 500 climbed 21.6%, and the Nasdaq soared 26.9%. Following their leads, most international markets have posted double-digit gains so far this year.

The average international equity fund returned 10.2% in the first half with only a handful of portfolios losing value. Even more impressive, among global equity funds — those that can invest in both U.S. and foreign stocks — not one reported a loss for the first half. The average global equity fund gained 11.1% for the period.

The top performing international equity fund as of mid year was the AMIDEX 35 Mutual Fund (AMDEX), which invests in stocks of Israeli companies. It returned 45.4% year to date as of June 30, getting an enormous 39.6% boost in the second quarter alone.

Wendy Trevisani, an associate portfolio manager at Thornburg Investment Management who helps run the Thornburg International Value Fund/A (TGVAX), noted that “many global stocks were badly beaten down.” She said her fund was able to take advantage of that, adding to unfairly punished positions, such as Julius Baer Holding, the Swiss-based global bank, Hyundai Motors, Korea’s largest automaker, and ASE Test Ltd., a Taiwanese semiconductor firm.

Ivo Kovachev, portfolio manager of the Driehaus European Opportunity Fund (DREOX), concedes that global markets have benefited from investors snapping up battered names. However, he cites two other major factors in the markets’ worldwide rise: the end of the Iraqi war, which removed much overhanging uncertainties, and the low interest rates in most of the developed world.

Europe: Healthy Markets, Feeble Fundamentals

Western Europe, still the main focus for U.S. investors putting money overseas, presents a paradox: The strong euro and relatively weak U.S. dollar makes Europe a great place for Americans to invest, but also makes it harder for European exporters to find buyers for their goods in the U.S. And although European stock markets have rallied in the second quarter, economic fundamentals on the continent remain patchy at best. Indeed, major countries such as Germany and France are possibly on the verge of recession. There is a widespread belief that equity markets in Europe have already priced in a recovery in late 2003.

In Europe, Trevisani is particularly bullish on the British Isles. “We are still seeing growth in Ireland,” she noted. “We own a large bank there, Bank of Ireland (IRE). We also are optimistic about the U.K., which features a growing housing market and rising consumer confidence: Tesco plc, the British supermarket giant, and Kingfisher, a U.K. retailing group, reflect our optimism, as does Pearson plc, the publishing company which owns the Financial Times.” She also likes European media stocks since “valuations in the sector have become very compelling, and they are leveraged to an economic turnaround.”

Justin Thomson, the London-based portfolio manager of T Rowe Price International Discovery Fund (PRIDX), sees good investment opportunities in European insurance and oil services stocks as attractive cyclicals, emerging pharma/biotech equities as long-term buys, and German small-caps for their valuations. Kovachev points out that small-cap stocks in Europe were outperformers in the first half, and that those in niche businesses have rallied this year. “Since they had no exposure to the U.S. market, they did not suffer from declines in the U.S. dollar; some of these names could still exhibit astonishing growth rates.”

Japan: Small-Caps Provide Relief

Japan, the world’s second largest economy, continues to be mired in a decade-long recession with little hope in sight. The country now faces the spectre of deflation.

Trevisani is cautious on Japan, where she currently has limited exposure. “The companies we do own are either export- oriented, like Canon, or non-financials, like NTT DoCoMo and NTT,” she said. “Valuations remain compelling in Japan, and we will continue to evaluate this region on a stock- specific basis.”

Thomson, however, likes what he sees in Japanese small-cap stocks, which have recently witnessed “significant institutional interest.” In fact, the fourth best foreign fund for the first-half was the DFA Invest Grp Japanese Small Company Portfolio (DFJSX), gaining a handsome 29.2%. Despite the gloom that seems to pervade Japan, the Nikkei still managed a 6.1% gain this year.

Emerging Markets: Rising, Still Undervalued

Emerging markets continued to deliver hardy returns, largely outperforming their more developed counterparts, with Eastern Europe and Russia offering a solid one-two punch. Latin American has also done well, pushed by a surging Brazil and a relatively stable Mexico.

Despite the gains made by emerging markets equities the past few years, Trevisani sees room for much more upside. “We’re seeing the best risk/return trade-offs in the emerging markets, due to both valuations and prospects,” she said. “Many stocks there are still trading at substantial and unwarranted discounts to their global peers.”

The Russian market, largely ignored by Western investors due to its small size and historical volatility, has continued to perform well. Two of the top five performing foreign funds so far this year invest there exclusively.

Far East: Hurt By SARS Threat

Asia’s mushrooming economies have been hurt by an unforeseen new woe, the outbreak of the SARS virus. Although the disease now appears to have subsided, it remains a factor that cannot be ignored.

China, the sleeping giant, has gradually transformed itself into a huge nation of consumers, as well as an exporting powerhouse, and is clearly the engine of future growth in Asia. “China has a huge, relatively fast-growing economy, with the additional benefits of cheap labor and production costs and a huge population,” Trevisani said. ” It is also a place of increased outsourcing.”

South Korea, a very strong performer in 2002, has stumbled this year, facing labor unrest at home, and the shadow of war with its hostile Communist neighbor to the North. Trevisani discounts South Korea’s ongoing geopolitical crisis with its North Korean enemy. “We feel this crisis will inevitably be resolved,” she said. “We look at South Korea as a very advanced emerging market, and we continue to believe in companies like Samsung and Hyundai, substantially undervalued at single-digit multiples when they are gaining market share from their western competitors.”

Looking Forward

While the apparent end of the war in Iraq has removed a dark cloud over global equity markets, the reasons for their recovery are varied, and, in some cases, unclear. Some stocks are simply bouncing back from deep lows, while others are supported by improving fundamentals as well decent corporate earnings. As a result, the outlook for the remainder of 2003 is shadowed with uncertainties, and the key question remains: Can global stocks retain their post-war gains and show strong momentum going forward? That remains to be seen.

–Palash R. Ghosh

INTERNATIONAL EQUITY FUNDS

Best PerformersMid-Year 2003 Returns (%)Worst PerformersMid-Year 2003 Returns (%)