Juliette Rossant

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"Czech-out time"

INVESTORS WHO YEARN to make a killing have seen some startling numbers in emerging markets lately: Russia, up 166% over the past year; Hungary, up 53%.

Before you dive in, listen to the cautionary tale of the Czech Republic, not long ago the shining light in the dim, former communist bloc.

"The fish is rotten from the head down," says Pierre Daviron, portfolio manager of Oppenheimer & Co.'s Czech Republic Fund. Adds Elisa Mazen, comanager, "We are looking for a single reason to stay. We haven't seen one yet."

In the past year the net asset value of this fund has dropped 0.7%. The showing would have been far worse if the fund managers hadn't seen what was coming. They shifted in April to a defensive strategy, with only 50% of the fund's assets in Czech stocks, down from 85% a year ago. If the fund continues with its defensive strategy, it could drop its Czech holdings entirely without even seeking shareholder approval.

"We started with 1,700 companies [on the Prague Stock Exchange], and now there are fewer than 20 worth even considering for investment," says Daviron.

In 1990, when the Soviet satellites were spinning off, the Czech Republic made all the right moves. It rapidly adopted a constitution, civil and criminal codes, free-market policies and a mass voucher-based privatization program. Oppenheimer launched the fund in October 1994, at a time of tremendous optimism, raising $60.5 million.

By the spring of 1995 Daviron, who has been manager of the fund since its inception, began to notice a gradual backsliding by the Czech government, starting with stepped-up preelection spending by Prime Minister Vaclav Klaus.

"He started saying that the transition was over, deluding himself that they had done what they had to do," says Daviron.

In fact, key elements in the transition had gone wrong. Laws had been passed, but no structure established for administering justice or handling bankruptcy. Publicly owned banks were encouraged to continue to lend to foundering companies in order to maintain bloated payrolls. The vouchers-for-shares program that privatized government-owned companies started well’Äîand ended badly. Controlling shares ended up in the hands of investment funds run by people more adept at siphoning off money for themselves than investing in growth.

"The population had 40 years of the communist saying: 'If you don't steal, you are stealing from your family,' " says Daviron sadly.

Just one example: Managers of engineering company Prvni Brnenska Strojina stripped the company's assets and transferred them to other companies in which they held shares. The few companies the Czech Republic Fund still owns are not screaming bargains. CKD Praha (1996 sales, $406 million) manufactures trams, diesel engines and locomotives. It has plenty of competition from much bigger outfits, like Siemens and GE. CKD trades at 13 times projected 1997 earnings. The average price/earnings multiple for the Prague Stock Exchange is 17.4. That's stiff in a nation that has yet to learn genuine capitalistic habits.

The Czech Republic Fund is shifting its equity investments to Poland, Hungary and Austria, but not to Russia.

Why not Russia? "The same people looting companies in Prague are doing it in Moscow," says Daviron. "Investors have no idea what they are in for."

Look out ten years, and the Czech Republic has lots of promise. In time the government will do the right thing. But getting from here to there is going to be painful and dangerous.

Moral: Don't invest in emerging markets unless you're prepared to sit through frightening setbacks. Get a fund that is well diversified among markets, has a record going back at least three years and has a reasonable expense ratio. The table lists seven worthy of your attention.

other reference pages on the web:
DIGEST 1/98: Abstrakty (Ekonomika)
CÀálˆ°nky prof. Milana Zelenˆ©ho
SYSTˆâMY POSTUPNˆâHO PREVODU VLASTNICTVˆç

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