Rachel Oliver looks at what investors want out of pooled funds.

The attitude of Europe's pension funds' to the emerging markets has at best been cautious, since the events in Asia. The recent turbulence felt on their own doorstep in Russia has not helped matters, and trustees are now being forced to re-evaluate their positions.

European investment levels in the region are, some admit now, thankfully small, and the traditional route for pension funds to access this area remains via pooled funds as the amount invested does not typically warrant taking a segregated approach. Alternatively the region has been in-cluded within a global emerging market mandate which again usually comes in the shape and form of a pool-ed vehicle. There are exceptions to this rule, however. In the UK, Hermes Investment Management which runs £30bn ($49bn) in assets for the BT and Post Office funds, previously has used pooled fund vehicles to ac-cess the emerging markets but is now investing directly in companies there, though Hermes probably is in the minority in taking this approach.

The Dfl20bn ($9.85bn) Dutch Metal Workers pension fund currently allocates less than $10m to the CEE markets and has a very small investment in Russian debt which is now of some relief, admits Wilhelm Von Oosten, who has responsibility for the Far East and Eastern Europe. Unfortunately we did not foresee the big fall which has taken place in these markets especially Russia otherwise we probably wouldn't have had any exposure at all," he says.

However, the plan is fairly optimistic for the future as it is readying itself to offer two further CEE segregated mandates in the next few months for approximately $50m to invest in the major markets of Russia, Poland, Hungary and the Czech Republic and the smaller ones of Turkey and the Baltic States. But, warns von Oosten, "If the outlook is not very good we might decide to postpone the decision of when we will enter into the markets and also the level of the in-dices will play a role."

The £11.2bn Railways Pension Fund in London uses several different managers who are allowed to include the CEE markets in their portfolio and the fund's market exposure is channelled through a mixture of segregated and pooled accounts. "There is hardly any money in there at all," says Robert Edgar, investment manager of Railpen Investments, the fund's in-vestment arm, adding "I don't think we'd have anything in Russia at the moment." The fund currently invests in Hungary, Poland, Czech Republic and Slovakia avoiding Russia primarily because of custody issues.

Says Edgar: "With the state of share registers over there and the fact that your name might be on the share register one day and someone comes along with a pencil and a rubber and it's not there the next day - that's not highly desirable!" Again the outlook is viewed as far more positive than the present state of affairs, signalling a likely increase in investment over time. "Looking forward in a few years time, obviously the more markets with good opportunities to invest in the better. Those particularly countries have developed reasonably well and as they get more plugged into the international financial systems and as they get closer to Europe, that's all to the good," he says.

The real onus, in this present climate, has been placed firmly with the manager of the pooled fund to readjust its portfolios on behalf of the pension fund clients who are airing their concerns. This is a particularly pressing issue once you compare the av-erage return data of CEE funds in the first quarter of 1998 compared to last year (see table). Most funds have underperformed the benchmark and the Russian turmoil will not have helped investors' confidence levels.

Since the asset allocation figures published in the table below, dated end April, the $53m Regent Eastern Europe Value Fund managed by Re-gent Pacific, which is currently 18% down on the year, has radically shifted in response to developments in central Europe. The asset allocation now stands at Russia 30%, Poland 21%, Hungary 25%, Bulgaria 6% and cash 10%, with the remainder divided between Croatia, Czech Republic, Romania and Slovenia.

Russia is of course the most problematic market, with its changing en-vironment making it difficult to make solid valuations on companies. Furthermore, commodity and oil prices have been dropping, the budget de-ficit is is very high, and the national banks lack the reserves to fight speculation against the rouble. Funds which take a stock picking approach are faced with the problem that Russia is full of companies in the midst of bankruptcy but which are still operating.

"We've been this year relatively cautious on Russia, we haven't had as high an allocation as we may have had in the past," says Philip Franklin, marketing manager at Regent in London. "But still 30% is probably quite aggressive." The Russian market has been very volatile all year, but Regent still feels there are still some good companies to be had with valuations back at 1996 levels, making the market "extraordinarily cheap" compared to other countries in the region. The fund still views Russia as the most compelling, but Bulgaria is also a favourite for future performance, and if Romania's privatisation process moves along the fund will adjust exposure accordingly, says Franklin. And the countries which are receiving the least amounts of fund flows - such as Croatia and Slovenia - look to be the benefactors of the future. This is largely based on the fact that Slovenia looks like it will be in the next wave in EU accession with Croatia not far behind.

The Hungarian market has been more the cause of regular re-evaluations for the $245m Vontobel Eastern Europe Equity Fund. In the past three months the allocation has shifted from 35% to 25% and is now back up at 30%. At the beginning of the year the market had been quite expensive, the elections were on their way and the market reacted strongly to this. The market has since settled down and companies are now reaching quite cheap valuations. "Hungary is the country without any doubt where you have the best companies," says fund manager Luca Parmajani, adding that the companies' clear strategy, good management and ag-gressive expansion into the eastern European markets will bring growth for the next five years.

The fund also strongly increased its weighting in Poland throughout December and January and is now up at 40%. "We still think that the macroeconomic situation in Poland is probably one of the best in the region," says Parmajani. Last year was a very different story with most of the western economies remaining very pessimistic about the situation in Poland especially as the current account de-ficit was increasing so quickly. But by the end of the year the deficit was not as big as expected, and now growth for 1998 has been reviewed and in-creased by the Polish government to more than 6%. Traditionally Poland has had one of the highest growth levels at an economy level, but compared to Hungary has less growth at company level. But now Parmajani sees an element of catch-up, boding well for future returns.

The security aspect of funds is likely to be of prime importance now and while Micropal does rate some funds on consistency of returns, in Europe it is only S&P's Fund Research and offshore fund specialist Forsyth Partners, both in the UK, who are actively developing formal A-grade ratings.

Fund Research's 'Emerging Markets-Europe' manual currently as-cribes a AAA rating to just two funds, Baring Eastern Europe and the In-vesco Europe Development Fund. A double-A rating is given to Credit Suisse European Growth, Fleming Flagship Eastern Europe and Pictet TF Eastern Europe. Two single country funds given three A's are Pictet's First Russia Frontiers Trust and the First Hungary Fund run by a private firm in New York, Rona & Tarsai.

The next Fund Research emerging Europe report is due to be published in September. Forsyth's ratings are due out this month. A preview of the findings shows that within the Emerging Markets module, only two eastern Europe funds gain a rating of any kind."