Few markets in recent times have been more compelling than those of the emerging nations of Europe, the Middle East and Africa. Fledgling and volatile, they have rewarded investors with nifty returns and not a few headaches. The potential has been clear -- ten European countries, including the Czech Republic, Hungary and Poland, will join the European Union in May -- though its realization has been spotty and fragmented.
As ever, strong performance attracts interest, and new money has begun to flow into the region's markets from developed-country investors as well as emerging-markets players. Some $727 million flowed into dedicated emerging EMEA funds in 2003, after net withdrawals of $103 million in 2002 and $852 million in 2001, according to EmergingPortfolio.com Fund Research, a Cambridge, Massachusettsbased firm that tracks international and emerging-markets fund flows and allocations. In the first six weeks of 2004 alone, investors pumped a further $730 million into dedicated emerging EMEA funds.
And no wonder: In 2003 Russia's market soared 70 percent, its third consecutive yearly gain, on the back of relative political stability and high oil prices. And MSCI's EM Europe index, comprising the Czech Republic, Hungary, Poland, Russia and Turkey, posted the highest local currency return of any emerging region in 2003, gaining 58 percent, compared with 55 percent for Latin America and 45 percent for Asia.
"One of the real drivers of the inflows into emerging-markets equity funds is the fact that emerging markets have outperformed developed markets in each of the last four years," says Brad Durham, managing director of EmergingPortfolio.com.
This year, recognizing this new investing dynamic, Institutional Investor presents for the first time the Emerging EMEA Research Team, spotlighting the brokerage firm research analysts who did the best job covering EMEA equities over the past year, according to portfolio managers and buy-side analysts surveyed by this magazine. These results were obtained by divvying up the voting in our All-Europe Research Team between developed and developing markets. In February we published rankings for 47 pan-European industry sectors, developed-markets macro disciplines and Western European countries.
This month's Emerging EMEA Research Team presents the results of voting in 12 EMEA research specialties. These include seven countries (the Czech Republic, Hungary, Israel, Poland, Russia, South Africa and Turkey), three regional industry sectors (Financials, Oils & Chemicals and Telecommunications) and two macro categories (Economics and Equity Strategy).
Acknowledged for the breadth and insight of its work in the region, UBS emerges as the clear-cut leader, securing ten team positions, including two first places, out of the 12 categories published. ING Financial Markets takes second place with seven team positions, followed by Merrill Lynch with six slots and Deutsche Bank with five. Renaissance Capital and Smith Barney Citigroup tie for fifth place, with four team positions each.
UBS's showing is consistent with its past performance in the overall All-Europe survey. Tallying team positions in the six EMEA country categories and one emerging-markets macro category that were included in the 2003 All-Europe Research Team, UBS would have taken first place, with five team positions, followed by Smith Barney Citigroup in second (four team positions), with Deutsche Bank and Merrill Lynch tied for third (three team positions). Four firms would have shared fifth place in this pro forma ranking, with two team positions each: CA IB International Markets, HSBC, ING Financial and Renaissance. (This year's five additional categories include the Czech Republic country category and the Emerging-Markets Economics macro category, which garnered too few votes to be published in 2003; we also added three industry sectors to reflect market practice.)
A strong showing across the board propels UBS to the top. "UBS has solid teams everywhere, and there are no gaps," sums up Jivko Moutafov, a senior analyst at Wells Capital Management in San Francisco, where he helps run $900 million in global emerging-markets equities.
UBS scores first place in Israel and Telecommunications. Its Israel team was correctly bullish on Israeli technology stocks, and its Telecommunications team recognized the value in Russian wireless telephone carriers Vimpel-Communications and Mobile TeleSystems, both of which more than doubled last year. Merrill Lynch (South Africa, Turkey and Financials), and CA IB International (Czech Republic, Hungary and Poland) turned in notable performances, with each securing three analyst teams ranked first in their categories. Deutsche Bank benefits from strength in Russia, the result of its November 2003 agreement to purchase a 40 percent stake in Moscow-based United Financial Group, which takes top honors in Oils & Chemicals (heavily Russia-influenced); Deutsche Bank places first in Equity Strategy. Moscow-based Renaissance Capital calls on its hometown strength to win the Russia category and gains two team positions in Oils & Chemicals and Telecommunications (second and runner-up, respectively); it earns runner-up in Equity Strategy.
What many of these firms have in common is a strong local presence in EMEA markets. "Firms like ING and CA IB International Markets are better at finding second-tier stocks and quickly reacting to a rumor because of their local offices," says one fund manager.
UBS, for example, maintains research offices in Israel, Turkey, Russia and South Africa. "We need to be there to add that local color and flavor," says Tutu Agyare, head of equities for emerging Europe. "It gives us close proximity to the markets and the companies and a feel for what is going on on the ground."
But like several of its competitors, UBS also covers emerging EMEA stocks by industry sector. "Our commitment to the region requires us to have both sector and country analysts," says Agyare.
"The issue in emerging markets is to balance country, regional elements and sector elements to provide a macro picture with sector trends," says Dan Lubash, co-head of global emerging markets at Merrill Lynch, who looks after the EMEA and Latin America regions. In particular, Merrill concentrates on economics, energy, financials, minerals, telecoms and strategy.
In this EMEA team, sector and country analysts alike excel at finding bargains for investors. In Israel, for example, UBS's Tel Avivbased team of Jonathan Half and Stephen Levey place first for a fourth year running with such stock picks as Nice Systems, a small-cap multimedia digital recording applications provider, which rose 188 percent last year. Merrill's No. 1 Financials team, led by Paul Tucker, issued a mid-June upgrade of Turkey's banking sector, including Türkiye Is¸Bank, based on a positive macro picture. Through year-end Is¸Bank shares rose 120 percent.
Yet for all the surging markets and swelling portfolios, the future isn't likely to bring rapid growth to EMEA research. "For the past couple of years, research has been shrinking," says Alexander Kazbegi, head of research at Renaissance. "EMEA's universe has not been growing much. Not at all."
Indeed, such major firms as Credit Suisse First Boston, Goldman Sachs International and Lehman Brothers are absent from this year's EMEA rankings altogether. CSFB, an EMEA research power in the late 1990s, has dedicated EMEA analysts following banking, energy, mining, telecoms and utilities and still has four analysts based in Moscow. Lehman and Goldman follow some EMEA names as part of sector coverage. But Goldman scaled back its EMEA research in 2001 and 2002, in part because of the bear market. "We had to either commit more resources or pull back," says Andrew Baird, Goldman's co-director of European research. "There were better commercial opportunities elsewhere across developed Europe."
Low market capitalizations and scarce investment banking business in emerging EMEA reduce the attractiveness of the markets. The combined market value of MSCI's Czech, Hungarian, Polish and Russian indexes at year-end 2003 was $63 billion -- just more than half of Finland's $123 billion market cap. At $113 billion at year-end, the biggest EMEA market is South Africa.
"Emerging markets are very volatile, and your commitment to resources and your head count need to be in a range where you are comfortable with bull and bear market conditions," says Paolo Zaniboni, head of EMEA equity research at Smith Barney Citigroup. His head count has remained constant at about 28 people since 2001, but the firm has shifted focus, cutting one analyst slot in Turkey and reducing coverage of Israeli tech stocks, while building up in South Africa.
Brokerages like ING Financial and J.P. Morgan are combining at least some Latin American and EMEA research coverage. The relatively small number of stocks in both Latin America and Eastern Europe makes the combination attractive economically, but it has not been popular with all investors. "It's a cheap excuse to cover them together," says Wells Capital's Moutafov.