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Fund Managers Fight for the New Europe

There are plenty of Europe funds out there, but some could get crushed.

Mutual-fund companies -- never ones to resist cashing in on a new investment theme -- are all over Europe like a cheap suit.

Soaring European markets and excitement about the euro have spawned a plethora of new funds. Since the beginning of 1996, 30 Europe-specific funds have been launched, bringing the total to around 50 by the end of October, according to

Lipper

. And year to date, an estimated $5.8 billion has poured into Europe-focused mutual funds, more than double the net inflow for the previous two years combined, says Lipper.

Investors have been royally rewarded. From the beginning of 1997, the

Morgan Stanley Capital International Europe

index has advanced 54%, powered by corporate restructuring, improving productivity and a huge increase in European mutual-fund flows into equities.

But as Europe gears up to adopt the single currency at the beginning of next year, mutual-fund investors may want to think before they plunge into the chart-topping funds.

Why? Because many of the growth stocks that dominate top-performing funds' portfolios may begin to falter as the euro ushers in a much harsher competitive environment. What's more, because Europe's economy is expected to slow markedly in 1999, there's a good chance such firms may report disappointing earnings next year.

Indeed, some Europe fund managers, pursuing the value-investment creed, expect high-profile earnings explosions among expensively valued stocks, and they're loading up on cheap-looking companies instead.

The Growth Model

AIM International's

(AEDAX) - Get Invesco European Growth A Report

Euro Development fund is a pack leader that has pulled ahead by filling its tank with high-octane growth stocks. This $126 million fund, set up just over a year ago, is the No. 2 Europe fund year-to-date with a 38.5% return, according to Lipper.

One feature that sets Euro Development apart from some of its growth-stock-focused peers is that it holds small- and medium-capitalization companies as well as larger names.

Jason Holzer, a senior analyst at the fund, says three sectors in particular have fueled its stellar first year: information-technology services, cellular-phone operators and fast food. Holzer disputes the notion that growth investment strategies no longer apply to Europe. Funds like his can continue to do well by identifying companies that are managing to improve profits growth through restructuring, he says.

If countries adopting the euro are headed for lower economic growth and poor profits next year, then it may be sensible to get into a growth fund with high exposure to countries outside the single-currency area.

One such fund is

Bartlett Capital's

(BEPFX)

Europe fund.

The $120 million Bartlett Europe has a comparatively large weighting in the U.K., which is staying out of the euro. It had around 35% in Britain at the end of October, compared with 12% each for France and Germany.

And even though the U.K. market has underperformed the rest of Europe this year, Bartlett Europe has not been hurt. It's the No. 1 Europe fund year to date, and it's been No. 1 over the past five years with a cumulative return of 145%, according to Lipper.

Manager Neil Worsley says that even though his fund favors growth names, it is concentrated in more defensive sectors like defense, telecoms and utilities.

European Investment Cocktail

Investors who want to mix growth with value investing may want to take a look at

Federated's

TheStreet Recommends

(EURAX)

European Growth fund. The fund's 20.4% year-to-date return puts it 35th among 50-or-so European funds.

Manager Frank Semack admits that the value approach has not done as well as growth. But he is certain that analysts' double-digit year-on-year earnings-growth forecasts for next year are unrealistic. "You'll see a lot of negative surprises among earnings announcements," he says, adding that profit upsets could set off wider market declines.

A Value Purist

Fund investors should not ignore the possibility that pure value investing may be the way to play Europe after two years of growth-stock exuberance.

Franklin Templeton's

(MEURX) - Get Franklin Mutual European Z Report

Mutual European is one fund that has not been chasing growth stocks with lofty valuations.

After a long period of underperformance, the $760 million fund could soon see many of its bets come through, just as other Templeton international funds have recently seen their value plays in Asia rocket ahead.

It's important to know, however, that the strategy of eschewing high-multiple stocks has cost it plenty of performance lately. Mutual European is the worst-performing Europe-wide fund year-to-date with a decidedly unimpressive 2.7% year-to-date return.

But the fund's manager, David Marcus, believes he will still get his time in the sun. "Value investing is absolutely the right approach for the new Europe," he says.

So what is Marcus buying? He focuses on holding companies that trade at sizable discounts to the value of the companies they own. Examples include France's

SGIP

, Italy's

CIR

and

Montedison

(MNT)

as well as Sweden's

Investor

.

Marcus also holds a 3% stake, worth some $650 million, in

Suez Lyonnaise des Eaux

, the large French water company that has climbed more than 29% since the beginning of October, when European markets bottomed.

More picks like that, and value purists will start to pull ahead. Indeed, don't be surprised if the new Europe brings a whole new set of winners.

This story was originally published on Dec. 10.