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Continental fund shift
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June 5, 1998: 4:39 p.m. ET
Europe is learning lessons of the U.S. and its funds are showing the benefits
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NEW YORK (CNNfn) - Domestic U.S. mutual funds may be getting all the accolades these days, but funds investing in Europe have been quietly laying claim to top honors among investment circles.
Since the beginning of the year, mutual funds which put their money exclusively in Europe have had returns of more than 27 percent, according to Lipper Analytical Services.
By contrast, money put in an S&P 500 index fund has seen returns of only 13 percent.
Investors have been cautious, to put it mildly, about sinking more money into funds investing in Southeast Asia, the previous hot spot for investors looking for an edge.
That region's troubles, ranging from currency devaluations to massive debt problems, have led them to look elsewhere. And their sights have settled on Europe.
One person who is currently reaping the benefits of Europe's resurgence is Karen Scott. As portfolio manager for ICON's South Europe Fund (ICSEX), she has guided her fund to lofty heights with returns of more than 56 percent in the past 12 months.
If Europe is the new hot spot, southern Europe is positively equatorial. Scott's fund, as its name would suggest, invests exclusively in the region.
This focus has enabled her to pick what are becoming the top markets, most notably Spain, Portugal and Italy.
Scott looks for value in her investments and she explained the current rush toward this area has made her job more difficult.
"That tends to happen when markets are turning in a good performance," she said. "People become attracted, from a momentum standpoint, to big returns."
That momentum has chased Scott away from one of her previous favorites: Italy. Once considered an ugly duckling by fund managers, domestic economic changes and Italy's inclusion into the European Union have pushed its values higher.
When that happened, Scott pulled much of her exposure out of Italy, instead switching to Switzerland.
Head of the class
Being a good student of U.S. economic and business trends has helped Europe find its way to some of the top honors among the investment community.
For years, U.S. firms have effectively trimmed the fat from their business operations and transformed themselves as they faced a new economic and trade environment.
Europe, however, lagged behind. "Europe was suffering from a competitiveness crisis," said Michael Porter, country fund strategist at Smith Barney.
Europe couldn't escape the competitive pressures forever, though. "Now, European corporations are addressing some of those issues."
In addition, Europe has followed the example of its American cousin, stepping up its merger and acquisition activity, not only within countries, but between European nations as well.
The most notable recent example was the sale of Vickers PLC's Rolls Royce luxury auto unit, a symbol of British sophistication, to Germany's Volkswagen AG.
Additionally, Europeans have learned something about subterfuge from across the Atlantic, said James Lister-Cheese, global strategist at Independent Strategy in London.
"There have been a lot of accounting tricks used in the United States which have improved earnings per share growth well ahead of operating profit growth," said Lister-Cheese.
"A lot of those tricks, regarding depreciation and debt servicing, are coming through to European accounting."
Smart and lucky
While Europe can take some credit for the resurgence of its investment interest, it can also thank an opportune business cycle.
The United States is currently in its eighth year of economic expansion and, said Lister-Cheese, it will be difficult to sustain its breakneck pace.
However, Europe, in its second year of expansion, is moving forward while barely breaking a sweat.
The strong investment interest in the United States had the effect of keeping the value of European issues lower.
"Now, there's more value to be unleashed," said Porter.
While Americans have been seeing the benefit of investing in Europe, continental investors have, in the past, shown less confidence about putting their money into the region's business.
Traditionally, many Europeans have preferred to keep their money in safer investments, such as bonds.
This strategy made sense for investors in countries like Italy, where the country was running large budget deficits and paying for it through the issuing of debt. Buying these government bonds could often pay the holder up to 8-10 percent.
However, the onset of European Monetary Union has changed all that, resulting in lower interest rates which have made bonds less attractive.
This has given rise to what Porter calls an "equity culture" which should bring even more money into Europe.
This increased investment, combined with stronger trade helped along by a single European currency, could boost European funds even higher in the years ahead.
"We have to assume that Europe has more legs," said Porter. "As long as we have those pillars, we would expect an upward trend."
When this happens, it will probably bring about the extinction of funds which invest only in certain countries or regions and instead investors will focus on sectors across national borders.
"In the future," Porter said, "buying a single country fund will be akin to buying an Iowa fund or a Massachusetts fund." 
-- by staff writer Randall J. Schultz
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