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Brett Arends’s ROI: How do you invest in Eastern Europe without Russia? One money manager explains

If you think you have it tough trying to allocate your investment portfolio, spare a thought for Joanna Sawicka. The Polish-born portfolio manager of the U.S. Global Investors’ Emerging Europe mutual fund 
EUROX,
-3.07%

just saw most of her investment universe get wiped—effectively — off the map.

Russian stocks accounted for about two-thirds of “Emerging Europe” indexes—and more than half the fund—until Vladimir Putin decided to invade Ukraine two weeks ago. Sawicka says she dumped almost all her Russian stocks on the first day of the invasion.

“I woke up in the middle of the night and I saw Russia was down 38%,” Sawicka says. She admits she was taken by surprise by the attack, like most other people. She had expected Putin just to take the disputed eastern provinces.

“When he invaded Ukraine we decided to sell the Russian names with very few exceptions,” Sawicka says. “We are a small company and we were quick to sell our Russian investments.” Many bigger institutions weren’t able to move that quickly, she adds, and are stuck holding Russian stocks they are currently unable to sell.

Those stocks, she adds, are now being written down “to zero” on their books. It is unclear if any Russian investments will be tradable again, or if so, when. Or if they will even have any value.

The index providers are currently removing Russia from the various emerging markets indexes. Vladimir Putin has succeeded in making his country an international pariah in his attempt to take over a country that has an economy smaller than that of, say, Peru.

Sawicka, who is now based in Texas. is following the crisis closely for personal reasons as well as professional. “I am from Poland, I was born in Poland,” she says. “I don’t only care about the investments, but the people. My heart is there. The situation is very dangerous. It is getting worse.”

But where do you invest an Eastern European fund if you can’t invest in Russia? “The biggest allocation is Poland, then Turkey, Hungary, Czech Republic and Greece,” she says. The situation is fluid, but currently around 20% of the fund is currently in cash, more than 20% is in Poland and nearly 20% is in western European stocks as well, she says.

There must be bargains aplenty for the brave. According to FactSet, Hungarian and Polish stock prices have collapsed by about a third since January in a liquidation panic. (Czech stock indexes are down by less than 20%, but they are hardly on the front lines of the crisis: Prague, we often forget, is west of Vienna. But the Czech index sports a dividend yield north of 6%, according to FactSet.) Sawicka says many Eastern European stocks are cheap, but admits fundamentals are going to have little effect on prices in the short term. “It’s oversold, it looks very cheap,” she says.

The usual advice for bold long-term investors is to buy during a sale, when prices are down — rather than during a boom, when prices are up. (Naturally it feels much easier to do the opposite.)

There is no reason why those saving for their retirement shouldn’t be investing responsibly in the region.

But U.S.-based individual investors looking to Eastern Europe don’t have many options. One is the U.S. Global fund, though its gross expense ratio, 2.8%, is high. BlackRock offers an exchange-traded fund, iShares MSCI Poland
EPOL,
+5.34%

with fees of 0.57%. Financial stocks make up nearly 40% of the fund.

Incidentally, few people are seriously arguing that Putin is likely to invade Poland But Poland, as a member of NATO and near the front lines of the crisis, can probably expect to start feeling a lot of economic love from the West.

There again, you may not have to go that far east if you want to go against the crowd in the current crisis. European markets across the board have tanked. The iShares Germany
EWG,
+4.02%
,
Austria
EWO,
+5.35%

and Eurozone
EZU,
+3.70%

ETFs have plunged by a quarter this year. And European ETFs, such as Franklin FTSE Europe
FLEE,
+2.67%

and Vanguard FTSE Europe
VGK,
+2.92%
,
which include the London market as well, are down by nearly 20%.

Small-company stocks tend to be more volatile than their bigger counterparts, falling more in a crash and rising more in a boom, which means they are often the better buy in a crisis if you can handle the volatility. The iShares MSCI Europe Small-Cap ETF
IEUS,
+4.56%
,
which is down more than 20% so far this year, has lowish expenses of 0.4% a year.

The impact of Russia’s isolation on broader “emerging markets” mutual funds is much more muted. Even before this crisis, Russian stocks accounted for just 4% of the main EM indexes, which at this point are about 50% invested in China and Taiwan.

It is worth recalling therefore that 10 or 15 years ago it was emotionally very easy to invest in Russia. Indeed back then Moscow was subject of an investment fad on Wall Street. The so-called “BRIC” countries—Brazil, Russia, India and China—were supposed to be The Next Big Thing in emerging markets and professional investors couldn’t get enough of them. The reward for doing the easy thing, as so often in the markets, has been disaster. Over the last 10 or 15 years none of the BRICs—not one—has outperformed an S&P 500
SPX,
+0.30%

index fund like SPDR S&P 500 ETF
SPY,
+0.34%

and investors in Russia have now lost their shirt buttons.

Let the record show that SG Securities’ strategist Albert Edwards called the fad near the peak, the Brit labeling the BRICs a “Bloody Ridiculous Investment Concept” in November 2011. Since then only the Indian market has even beaten the Vanguard Total World Stock fund
VT,
+0.72%
.

Today, most people probably think risking money in Eastern Europe is a bloody ridiculous investment concept—which is why it might not be.

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