Why Five Unusual Funds Are Topping the Charts

We usually try to avoid drawing attention to narrowly focused funds that top the short-term charts. They get enough publicity elsewhere. And they often end up at the bottom of the short-term charts a few months later.

But when a number of unusual funds show up at the top of the five-year charts--as is currently the case in several international categories--they're hard to ignore. What's more, many of you (you know who you are) have been clamoring for information about them.

To be clear, discussing these funds does not mean we're recommending them. In fact, after looking at why these funds boast high rankings and examining their structures, few if any qualify as appropriate picks for a typical portfolio.

Awash in Oil--and Cell Phones
With Western Europe struggling with slow economic growth, funds that target Russia and other former communist countries in Europe appear prominently on the charts of five-year winners through April 15, 2004. ING Russia  and Third Millennium Russia  claim the top two spots in the Europe-stock category, with annualized gains of 52% and 38% respectively. (The category average is a mere 3.6%.) U.S. Global Investors Eastern Europe  and  Vontobel Eastern European Equity  land in third and fifth places, respectively.

The Russia funds land on top largely because of oil. Big oil companies (along with a handful of other natural-resource firms) dominate the Russian stock market. ING Russia currently socks 30% of its assets in just two oil giants, Yukos and Lukoil. Oil prices have been strong for some time, and these funds have ridden the wave.

But that's not the only reason they have thrived. Russian stocks in general have benefited from the impression of political stability after the perceived chaos of the Yeltsin era--even though disturbing questions have arisen about the country's legal and electoral practices. And while energy plays have been lucrative, so has the new game in town: mobile phones. (In countries with shaky landline systems, the new technology rapidly gained widespread appeal.) In fact, the Third Millennium fund's top holding is not an oil giant, but Vimpel-Communications (VIP), which has gained 46% annually over the past five years, including a 175% gain--that's not a misprint--over the trailing 12 months.

Banking on Convergence
Oil stocks have even less impact on Vontobel Eastern European's portfolio. The fund does own some Russian stocks (currently 11% of assets), but it devotes more than 60% of its money to Poland, Hungary, and the Czech Republic--primarily banks and big telecom firms. And those stocks have benefited from "convergence." Unlike Russia, these three former Soviet satellites have been on track to join the European Union for many years now (the official date of accession is May 1). That expectation has fueled enthusiasm for their stocks, with the idea that interest rates, business skills, and other traits will gravitate toward Western European norms.

The U.S. Global Investors fund splits the difference between Russia and Central Europe. With nearly half its assets in Russia, it has enjoyed that market's oil and mobile-phone boom, but a top-10 packed with Central European banks has enabled it to capture those markets' gains as well.

Meanwhile, the top diversified emerging markets offering over the trailing three-year stretch (it hasn't been around for five) owes its place to similar trends. T. Rowe Price Emerging Europe & Mediterranean (TREMX) has one third of assets in Russia. Another third of assets is invested in Turkey, and that stake has been propelled by that country's improving financial condition and--what else?--cell phones. Top holding Turkcell (TKC), which takes up more than 9% of assets, has zoomed more than 100% over the past 12 months. Thus, the fund's focus has enabled it to beat rivals that put most of their money in Asia and Latin America, which, despite some great rallies, haven't fared quite as well as this offering's targets.

You Knew This Was Coming
All in all, these stories show that trends that propel narrowly focused funds can continue on for quite awhile. If you're thinking of investing in these or similar funds, though, here's the warning you knew was coming. It's not just that these funds typically have a narrow focus on one market or just a few, some of those markets can be extremely volatile (ING Russia lost 83% in 1998), and the funds frequently pack substantial assets into just a handful of holdings. In addition, many of these funds also suffer from high expenses and changing managers. Those factors add two more reasons to approach them with a high degree of caution.