Jan. 3, 2005 — On the heels of a strong 2003, equity markets across the globe again posted positive returns in 2004, in most cases outperforming U.S. stock markets.

Given improving fundamentals, low interest rates, high commodity demand, modest inflation, and the weak U.S. dollar, overseas funds were especially buoyant. The average international stock fund returned 19.3%, versus a gain of 10.7% for the S&P 500-stock index.

The year’s top-performing foreign equity portfolio, the Metzler/Payden European Emerging Markets Fund, soared 53.3%, with heavy exposure to such surging economies as Poland and Hungary.

The average global equity fund — those with the flexibility to invest in both international and U.S. stocks — climbed 14.5% for the year. The best performer in this class, Oppenheimer Global Opportunities Fund/Y (OGIYX), surged 30.4%, buoyed by a 27.4% jump in the fourth quarter alone.

Emerging Markets: Latin America and Eastern Europe Soar

In a continuation of 2003, emerging markets led the pack again, particularly the dynamic and evolving economies of Latin America and Eastern Europe. Latin funds were driven by robust performance from oil-rich Mexico and Venezuela, up 45.0% and 45.5%, respectively; Brazil; up 30.5%; and a resurgent Colombia, up 125.7%.

“Latin American markets tend to exaggerate the movements in the U.S.” noted Milton Ezrati, senior market strategist at Lord Abbett. “When U.S. stocks rally, Latin equities surge; when the U.S. declines, Latin issues plummet.”

While Mexico’s strength can be largely attributed to high crude oil prices and a steady export business to the U.S., Brazil’s healthy markets have been supported by a strong internal economy, corporate and pension reforms, China’s tremendous appetite for Brazilian commodities, and evidence that President Luiz Inacio Lula da Silva is committed to market-friendly policies.

Eastern European markets continue to thrive, despite tepid performance in Russia. Soeren Rytoft, fund strategist for the Metzler/Payden European Emerging Markets Fund, said the region has entered a “transitional” phase, given that ten area countries joined the European Union in May; while two others, Romania and Bulgaria, are expected to join by 2007. Turkey remains a longer-term possibility.

“Aside from the ongoing benefits of EU convergence, Eastern European economies feature low labor costs, low corporate taxes, Western-style corporate governance and a high degree of foreign direct investment flowing in, particularly from Western Europe,” Rytoft noted. But after four solid years, he cautions that Eastern European markets may enter into a cyclical slowdown next year. That’s only because “we’ve seen such exorbitant growth over the past few years, and because Western European economies will likely taper off,” he says.

After more than doubling in value in 2003, Russia’s stock market essentially flattened this year, despite robust oil prices. Rytoft lays much of the blame on the bankruptcy and scandals engulfing energy giant Yukos. “There is some anxiety on the part of investors that Yukos’ woes may spill over into other Russian companies,” he said. “However, once we get out from under the Yukos cloud, foreign investors’ confidence should be restored.”

Going forward, Ezrati noted that higher interest rates in the U.S. may hurt the emerging markets by limiting their ability to borrow money, since many developing countries possess dollar-linked currencies, and issue debt denominated in dollars. However, on the whole, Ezrati said he is forecasting “strength in the emerging markets,” especially in the early part of the year, based on high commodity prices, and continued global demand, especially from the U.S. and China.

Western Europe: Strong Euro Inflates Returns

Strongly linked to the performance of U.S. equities, Western European markets outperformed their American counterparts in 2004, but almost entirely due to the continued supremacy of the euro over the dollar. “If you take away the currency translation effect, Western Europe presents a mixed bag,” Ezrati said.

To be sure, larger nations like France and Germany have delivered relatively lackluster returns, while certain smaller nations, notably Austria, Greece and Norway, have appreciated in excess of 40%. In fact, the top-performing exchange-traded funds for 2004, the iShares MSCI Austria Index (EWO), rocketed 70.9%.

The weak U.S. dollar presents a dilemma for investors. In the short-term, a feeble greenback automatically boosts foreign stock price. But over the longer-term, a cheap dollar hurts large-cap global companies, particularly in Europe, since they are dependent on exports to the U.S. “If the U.S. dollar finally corrects and strengthens a bit, the large-caps in Europe will finally move up,” said Ivo St Kovachev, portfolio manager of Driehaus International Discovery Fund (DRIDX). “Large-cap European indices were quite weak in the fourth quarter of 2004.”

Going against consensus, Ezrati believes the dollar has bottomed out against the euro, setting the stage for more stability in global currency markets.

Japan: Solid, But Doubts Linger

Japan, the world’s second largest economy, posted a respectable 14.7% return on the year, but questions abound about the country’s economic health.

“I’m skeptical about Japan,” Ezrati said. “They haven’t really enacted the massive financial reforms they need to; and with their banks still heavily burdened, they’ll have trouble creating domestic credit, which really hamstrings their economy.”

Although it is far too early to assess the economic fallout from the recent devastating tsunami-earthquake upon South Asia, it is obvious that the tourism industries of Thailand and Sri Lanka will be immediately damaged, and will require enormous amounts of capital to rebuild.

International Equity Funds

Best Performers 2004 Returns (%) Worst Performers 2004 Returns (%)
Metzler/Payden European Emerging Markets Fund +53.3 Blue and White Fund/C -12.0
U.S. Global Eastern European Fund (EUROX) +52.4 Commonwealth Japan Fund (CNJFX) -3.1
Vontobel Eastern European Equity Fund (VEEEX) +48.9 Hallmark Equity Srs Trust Intl Small Cap/R (HISRX) -2.8
AIM European Small Company Fund/A (ESMAX) +43.7 Eaton Vance Asian Small Companies/B (EBASX) -0.3
Merrill Lynch Latin America Fund/I (MALTX) +43.6 Dreyfus Premier Greater China Fund/B (DPCBX) +1.7
Best Performers Fourth Quarter 2004 Returns (%) Worst Performers Fourth Quarter 2004 Returns (%)
Eaton Vance Greater India/A (ETGIX) +27.8 ING Russia Fund/A (LETRX) -3.6
Bernstein Emerging Markets Value Port (SNEMX) +24.8 Third Millennium Russia Fund (TMRFX) -0.6
Merrill Lynch Latin America Fund/I (MALTX) +23.5 Blue and White/C +1.1
Fidelity Advisor Latin America/Instl (FLNIX) +22.4 Commonwealth:New Zealand Fund (CNZLX) +1.8
AIM European Small Company Fund/A (ESMAX) +22.1 Commonwealth Japan Fund (CNJFX) +2.2

Global Equity Funds

Best Performers 2004 Returns (%) Worst Performers 2004 Returns (%)
Oppenheimer Global Opportunities/Y (OGIYX) +30.4 GMO Alpha Only Fund Class III (GGHEX) +2.6
Templeton Global Smaller Companies/B +27.7 Prudent Global Income Fund (PSAFX) +3.4
AIM Global Aggressive Growth Fund/A (AGAAX) +24.4 Citizens Global Equity/Retail (WAGEX) +3.4
Evergreen Global Opportunities/I (EKGYX) +24.1 Janus Aspen Srs:Worldwide Grth/Svc II +3.9
Polaris Global Value Fund/Investor (PGVFX) +23.6 DFA Global 25/75 Portfolio/R +4.1
Best Performers Fourth Quarter 2004 Returns (%) Worst Performers Fourth Quarter 2004 Returns (%)
Oppenheimer Global Opportunities/Y (OGIYX) +27.4 GMO Alpha Only Fund Class III (GGHEX) +0.2
Scudder Global Discovery Fund/S (SGSCX) +18.9 Federated Market Opportunity Fund/C (FMRCX) +1.1
Evergreen Global Opportunities/I (EKGYX) +18.8 DFA Global 25/75 Portfolio/Instl +3.1
Templeton Global Smaller Companies/B +18.1 Templeton Global Long Short Fund/A (TLSAX) +4.7
Credit Suisse Global Post Venture Capital/Cmn (WVCCX) +17.5 Prudent Global Income Fund (PSAFX) +6.2

Exchange-Traded Funds

Best Performers 2004 Returns (%)
iShares MSCI Austria Index (EWO) +70.9
iShares MSCI Mexico (Free) Index (EWW) +48.3
iShares MSCI Belgium Index (EWK) +43.9
iShares MSCI South Africa Index (EZA) +43.6
iShares S&P Latin America 40 Index (ILF) +39.0

Source: Standard & Poor’s. Total returns are in U.S. dollars and include reinvested dividends. Preliminary data as of 12/31/04.

Contact Bob Keane with questions or comments at:bkeane@investmentadvisor.com.