The saga of Russian oil giant

OAO Yukos

continues to get stranger and more twisted as 2004 draws to a close. For investors in Russian equities, it's been a disappointing end to what started off as a banner year.

The machinations, with the government saying Thursday that Yukos was being refashioned into a new state-owned company minority-held by China National Petroleum, have turned a 38% gain in the Russian Stock Exchange's RTS Index through April into an under 7% gain for the entire year.

Of course, for U.S. investors, currency moves have been the saving grace. The dollar has depreciated vs. the ruble and other European currencies, improving the stock market returns for those in the U.S. The S&P-RTS Index denominated in dollars rose this year from 136.7 to 161.97, an 18% gain.

The

Central Europe & Russia Fund

(CEE) - Get Report

, a closed-end fund traded in dollars on the

New York Stock Exchange

, is up 37% over the past year and it's still at an almost 11% discount to the value of its assets. Only about half of the fund was in Russian securities, with 22% in Poland and 11% in Hungary as of the end of August.

Luckily for energy consumers, though the Yukos saga was said to be driving world oil prices higher back in July,

the tempest didn't last long. Oil has barely been affected by the most recent tragicomedic twists.

Looking ahead to 2005, contrarians might be tempted to wade into the area. After all, the Russian market lagged most of its emerging-market brethren and Putin's anticorporate behavior and other blunderings have dismayed virtually all western investors.

Then again, it's sometimes said that everything is darkest just before it goes pitch black. There's not much reason to hope Putin is going to get back on the virtuous path anytime soon, and if oil prices decline, the country's huge energy sector will suffer.

"It has throttled our long-term optimism on the country," says Mike Conelius, manager of the

(PREMX) - Get Report

T. Rowe Price Emerging Markets Bond Fund. "They seem to be going back in time and that's keeping money offshore and limiting their growth potential." In bonds, T. Rowe has shifted from overweighting Russia to a neutral weight, he says.

For those who were already bearish, the Yukos story has been vindication.

"There are some very subtle clues that indicate a company might be in trouble that a weathered financial analyst can tease from the footnotes of financial reports, and then there are far less subtle clues, like the entire management fleeing abroad to avoid prosecution" writes Marco Vangelisti, fund manager at Grantham Mayo Van Otterloo & Co. Russia is the biggest underweight in the company's emerging-equities accounts.

Even so, on other fronts, Russia is moving in the right direction. Last week it announced plans to break up the vast government run electric utility Unified Energy System in a bid to attract outside investment for its ailing power infrastructure. And there has been no backtracking on the $2.6 billion deal letting

ConocoPhillips

(COP) - Get Report

buy a stake in Lukoil.

Looking out more broadly at emerging markets globally, there were other setbacks, albeit on a much smaller scale. In Argentina, President Nestor Kirchner continued to disappoint international investors with his meager offers for restructuring the country's $100 billion of defaulted debt. Ukraine's rocky presidential election may have come out all right in the end but it surely put a damper on investors' desire for stability.

Those problems were the exceptions rather than the rule. Most governments followed "prudent macro-economic policies,"

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Pimco Emerging Market Bond manager Mohamed El-Erian noted in his recent year-end essay explaining positive performance for the sector.

In Brazil, populist President Lula reassured investors he wasn't about to bury the country in more debt. The amount of extra yield bond investors demanded for owning Brazilian debt compared to U.S. Treasury bonds has plummeted from 20 percentage points to under four percentage points in the past two years, and the Sao Paulo Stock Exchange's Bovespa index rose 18% in 2004.

Again, currency effects helped U.S. investors. Among exchange-traded funds, for example, the

iShares Brazil Fund

(EWZ) - Get Report

gained 33% and the

iShares Emerging Markets Fund

(EEM) - Get Report

added 24%.

For mutual funds, emerging-market stock funds gained 22% on average, better than any of the major U.S. equity categories, according to Morningstar, while their fixed-income equivalents also hit the top of the charts, gaining an average of 12%.

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Dimensional Emerging Markets Value Fund led the equity group, gaining 38%, while Grantham Mayo's

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GMO Emerging Country Debt IV was the best for bonds, rising almost 19%.

El-Erian, whose fund gained 11%, says the fundamentals in most countries look great for 2005.

The outlook "would be unambiguously favorable if one were to focus exclusively on bottom-up considerations -- namely, invest on the back of the growing number of emerging economies that are increasingly in the grips of a virtuous economic, financial and technical cycle," he writes.

But, always a "but" at Pimco, emerging markets remain at risk if larger global economic problems explode, like a crisis sparked by the falling dollar or declining growth in Europe.

"There is a limit to the extent to which EM (emerging market) assets can fully decouple from global developments," El-Erian says. "Put differently, what appears to some to be a narrow stake on EM internal fundamentals is in fact a big wager on a stable external environment."

T. Rowe's Conelius likes Turkey and Serbia for 2005, as well as Brazil, although he says the opportunity there is "somewhat played out." Turkey's market has already gotten a jump on rivals after the European Union agreed last week to initiate membership talks.

As for Yukos, "I wouldn't paint the latest news as a broad brush against Eastern Europe or emerging markets overall," Conelius says.

For investors aiming to hit a diversification bull's-eye away from the U.S. market, keep in mind that there are plenty of non-Russian shooting galleries where promises are made to rock away, rock away.

In keeping with TSC's editorial policy, Pressman doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send

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