International Herald Tribune: Good times for bonds, Russia and tech stocks There were few good reasons to move out of bonds and into mainstream equities during the first quarter. The average offshore bond fund rose 3.39 percent, while the average offshore equity fund dropped 5.11 percent. U.S. equity funds fared little better, with the average fund losing 3.85 percent. The average U.S. bond fund climbed a modest 2.8 percent. Raffaele Bertoni, a fixed-income fund manager with Dublin-based Pioneer Investments, said that he did not expect a large-scale sell-off of fixed-income assets this year. But neither does he see much upside potential. "Returns will probably come from bond coupons and not from capital appreciation," he said. "We expect fixed-income assets to yield around 2.5 percent during 2003." Dutch equity funds were among the poorest-performing funds in Europe, with many posting losses in double digits. Solvency concerns forced many of the large Dutch and German insurance companies to offload equity holdings and move into cash. This had a detrimental impact on the market, analysts said. Gold investors also suffered, with four of the bottom ten U.S. mutual funds dropping 14 percent to 16 percent. This ended an impressive 12-month run by gold funds. Gold has historically flourished during periods of economic and political instability. Current geopolitical risks coupled with weak economic data and a falling U.S. dollar have provided a perfect environment for gold funds. But the general consensus is that these funds have the best of their gains behind them. Hopes for a broad-based equity rally are being pinned on a postwar economic recovery. If this does not materialize, the markets could be in for still more misery, according to Roger Guy, who runs Gartmore's European equity fund. Despite volatile investment conditions, Guy's fund is still attracting capital inflows. But economic data has been disappointing, according to Guy, who is looking to move into defensive areas such as food, oil and pharmaceutical stocks - "anywhere that has high and sustainable yields," he said. It was not all doom and gloom for European equity investors. Three of the top-performing offshore equity funds were invested in Russia. Careful stock selection enabled fund managers at Prosperity Capital Management to significantly outperform Russia's main index, the Russian Trading System Index, which rose just 0.4 percent for the quarter. Prosperity Capital Management also was helped by overweight positions in the power and fixed-line telecom sectors. "The power sector is undergoing restructuring and increased interest in the sector has driven power stocks higher in recent months," a spokesman, Paul Leander-Engstrom, said. "Russian strategic investors are keen to acquire shares in utilities companies. We positioned ourselves in the secondtier players that we believed would draw the interest of Russian and international buyers." Tyumen Oil Co. is one of the stocks that the three top-performing Prosperity funds were overweight in during the first quarter. The purchase of a 50 percent stake in Tyumen by BP PLC earlier in the year helped the stock outperform its peer group, according to Engstrom. Yukos Oil Co., another key holding in the Prosperity funds, also helped overall performance. The Prosperity Cub Fund did better than the flagship fund, Russian Prosperity, because of a higher exposure to mid-capitalization stocks, which have come back into favor. "The flagship fund has to have a higher weighting in blue-chip stocks, which have not done as well as the market," Engstrom said. Russian Prosperity climbed 8.3 percent in the first quarter, while Prosperity Cub shot up 14 percent. Prosperity Quest 2 Power led the field with first-quarter gains of 27 percent. "International investors are waiting for a fall in the price of oil before committing money to Russian equities,"' Engstrom said. "But domestic investors, faced with negative real interest rates, are exhibiting an increased appetite for this asset class. We anticipate annualized returns of around 25 percent over the next three years." Engstrom is looking for companies with reasonable dividend yields and the potential for further share-price growth. "A good example would be Sibneft, an oil company which has a free float of less than 15 percent and a market capitalization of $10 billion," he said. "There is a chance that one of the oil majors will acquire the company at some point." In the United States, aggressive science and technology funds staged a rally. The average U.S. science and technology fund gained 3.5 percent during the quarter, according to Standard Poor's Corp., which compiled the data for the accompanying tables. A spokesman for RS Information Age and RS Internet Age, two top-performing U.S. mutual funds, said fears that a war in Iraq would freeze spending on technology proved unfounded. Also, "firstquarter earnings estimates were set at more realistic levels," he said. The RS funds favor small- to mid-capitalization companies, with its largest positions in eBay Inc. and Expedia.com Inc. In the semiconductor sector, the fund favors O2Micro International Ltd.and Marvell Technology Group Ltd. Two of the best-performing investments in the first quarter were Kana Software Inc., up 58 percent, and Retek Inc., up 71 percent. Amerindo Technology topped the U.S. mutual fund chart, posting a gain of 28.5 percent. This was largely due to outsize stakes in a small number of top-performing stocks: Around 50 percent of the fund was invested in eBay, Expedia and Yahoo Inc. Amerindo Technology has had a volatile performance history. The fund's best year was 1990, when it gained 250 percent. In recent years the fund has performed poorly, losing 57 percent in 2001 and 312 percent last year. It remains to be seen if 2003 will reverse the previous years' losses. High-yield or junk bonds have been a tough place to invest during the last five years, but it is a sign of the times that returns in the last two quarters have been robust. Lowest-rated bonds have done best, with many posting high double-digit returns. Tom Soveiro, a high-yield fund manager with Fidelity Investments, said that corporate America was finally getting its act together. "There has been a shift in the corporate mind set," Soveiro said. "Companies are striving to get rid of debt and repair balance sheets. If this trend continues and the economic outlook remains uncertain, high-yield bonds, especially the riskier types, should do well." Joe Brennan, an investment analyst with Vanguard Funds, is also positive on junk. If the credit environment improves and default rates come down, he said, high-yield will outperform and provide a buffer against paltry returns from quality fixed-income securities. But he cautioned, "High-yield bonds tend to trade in line with equities, so any major disruption to the equity markets could have a detrimental effect."