Not so long ago Russia boasted an unenviable reputation for its peculiarly corrupt brand of capitalism. Now Russia is working hard to clean up its act. With many of Russia's former communist colonies now preparing for European Union membership, the feelgood factor is beginning to spread.
Bear markets may be commonplace, but Russia has managed to stem the tide spectacularly. Over the past 12 months, its benchmark RTS Index has surged by 57 per cent. The Prague PX 50 and Budapest BUX are not far behind in dollar terms at 51 per cent and 35 per cent respectively. In spite of this performance, eastern Europe has remained off the radar of most UK investors. The old Warsaw Pact nations crop up in most global emerging markets funds, where they clamour for attention with the bourses of Asia and South Africa.
Specialist UK funds are rare, though there is a wider choice offshore. The UK's two specialist unit trusts, JPMF New Europe and Credit Suisse European Frontiers, are mutual fund minnows. They boast just Pounds 14m between them in spite of double-digit returns over the past 12 months.
Next week they will be joined by the new Jupiter Emerging European Opportunities Fund. It will be managed by Elena Shaftan, who has run the Luxembourg-domiciled CB Emerging European Market Equity Fund on behalf of Commerzbank, Jupiter's parent, for the past two years.
Ms Shaftan is excited by the possibilities, especially for Russia, which is expected to account for around 45 per cent of the initial portfolio. She cites a robust economy, the structural changes that President Vladimir Putin has introduced in an attempt to stamp out "gangster capitalism", the prospect of Russian entry into the World Trade Organisation and warmer relations with the US since September 11.
"Retail sales are growing by 15 per cent (a year); disposable income is up by 25 per cent," says the former student of Latvia's Riga University. "You can see it happening and the economy changing. The structural changes are here to stay."
Mark Robinson, manager of the JPMF New Europe Fund, argues that the crisis of 1998, when Russia defaulted on its debts, was a watershed. Moscow realised it would not have a second chance to put its house in order.
"It has had a very impressive reform programme," he says. "Tax reforms have been passed and implemented and it has kept a tight grip on spending.
"The domestic economy depends on the oil price. But Russia has a natural competitive advantage as its exploration costs are a fraction of the costs that multinationals face. Anything above Dollars 15 a barrel is comfortable for Russia."
However Neil Gregson, manager of Credit Suisse European Frontiers, adds a note of caution. "Valuations still look cheap, but there are still some corporate governance issues." In Russia's former satellite states the buzzword is "convergence", with Hungary, the Czech Republic and possibly Poland leading the push towards EU membership.
"Several countries are aiming to join the euro by the beginning of 2006," says Ms Shaftan. "That's a very ambitious target, but their governments are trying to institute reforms."
She sees a loosening of monetary policy stimulating growth. Hungary, for example, should see interest rates fall from 9.5 per cent to the 3.25 per cent of the eurozone. Furthermore, household lending, currently a fraction of levels in the west, is predicted to explode. These factors could stimulate economic growth of 6 per cent in Hungary next year compared with Germany's 2.5 per cent. Yet eastern European equities still trade at a 50 per cent discount to the west.
Mr Gregson is more cautious, pointing out that eastern Europe's exporters depend on the health of the eurozone economies for most of their business. The post-communist countries also suffer from a lack of breadth in their stock markets, with mutual funds relying heavily on the energy, banking and telecoms sectors.
However, oil and gas companies, headed by Russian heavyweights Yukos and Lukoil, trade on much lower price/earnings ratios than western multinationals in spite of Russia's vast reserves.
As for telecoms, fund managers are salivating over the low level of mobile penetration in the east. "Russian mobile penetration was 5.5 per cent at the end of 2001," says Mr Robinson.
Ms Shaftan likes Mobile Telesystems of Russia, which is more than doubling consumer numbers year-on-year. Matav of Hungary, in which Deutsche Telekom is the majority shareholder, also crops up across the funds.
There is a consensus that the east's telecoms boom won't mimic the bust of western Europe, thanks to lower levels of debt and the benefit of hindsight in valuing 3G licences.
Banks such as Komercni Banka of the Czech Republic and Hungary's OTP are tipped to benefit from the explosion in consumer borrowing.
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