Eastern European stocks have been sizzling, but for ETF investors the region remains tantalizingly out of reach. A leading index tracking shares in Russia, Poland, Hungary and the Czech Republic jumped 21.5% in local currencies in 2004. In dollar terms, last year's gain was 32.1% -- nearly triple the S&P 500's rise. Active managers running Eastern European open-end mutual funds have been doing better still. The $7 million ( MPYMX) Metzler/Payden European Emerging Markets fund and the $54 million ( VEEEX) Eastern European Equity fund rose 53% and 49% respectively in 2004. For all those impressive results, though, investors in exchange-traded funds are stuck on the outside looking in. None of the big three ETF houses -- Barclays, State Street and Bank of New York -- offers a so-called exchange-traded fund that tracks the leading regional index, the MSCI Emerging Markets Eastern European Index. Nor has any created a country-specific index for these four nations. Investors like ETFs because they afford a liquid and transparent way of investing in regions or sectors. To be sure, there are some ETF plays that offer some limited exposure to the region. Barclays, the leader in international ETFs with more than $30 billion in assets, currently sponsors an iShares MSCI Emerging Markets ( EEM) ETF. But it is heavy with Latin America and Asian companies, leaving a paltry 10% or so of its portfolio for Eastern European stocks. Likewise, the firm's iShares MSCI European Monetary Union Index ETF ( EZU) excludes the eight Eastern European countries admitted last May to the European Union -- including the Czech Republic, Hungary and Poland -- because those nations don't yet use the euro as their primary currency. A Barclays spokeswoman says the company hasn't seen enough demand to merit either an Eastern European or a country-based ETF. She says the firm "would be open to considering such a product if the market decides there's a need for one." State Street says it isn't planning one now either.
Without a major provider on board, ETF investors interested in the region will be scrounging for alternatives. One that worked well last year was the iShares MSCI Austria ( EWO) ETF, which jumped 73% in 2004 as Austria cemented its role as a gateway to Eastern Europe. "Austrian banks are booming with lending deals now that Vienna has evolved into a hub for Eastern European commerce," says Soeren Rytoft, portfolio manager for Metzler/Payden European Emerging Markets fund. Closed-end funds specializing in Eastern Europe and Russia provide another option for investors looking for a fund that trades much like a stock. Like ETFs, closed-end fund shares are listed on securities exchanges and trade intraday on the open market. But closed-end funds are actively managed and can trade at a premium or discount to their net asset value -- whereas ETFs are tied directly to the performance of an underlying index. For example, the Templeton Russia & East European ( TRF) closed-end fund recently traded at a 1.1% premium to its $35.64 NAV. Another closed-end fund option, the Central Europe & Russia Fund ( CEE), traded at a 9.26% discount to its $30.03 NAV. The TRF and the CEE rose 44% and 23% respectively last year. Richard Shaker, a closed-end fund specialist at Maryland-based Shaker Financial Services, advises individual investors to avoid buying closed-end funds with juicy premiums. "Large premiums are often unsustainable," says Shaker. "But if you can pick up a good fund at a small premium or a discount, you can often benefit from the fund's management." Expense ratios for closed-end funds are also substantially higher than for ETFs. The TRF and the CEE charge 1.84% and 1.5%, respectively, compared to 0.85% for the average international iShare. But these are problems investors are going to have to live with until demand dictates the introduction of an Eastern European ETF.