Federated InterContinental Fund Favors Chinese, Brazil Stocks

 Federated Investors Inc.’s InterContinental Fund doubled its emerging-markets holdings last year and favors Chinese, South Korean and Brazilian stocks in 2010, said Audrey Kaplan, the co-head of international equities.

The $710 million fund, which beat its benchmark and rivals over the past five years, increased investments in developing countries to 46 percent from 23 percent about a year ago, Kaplan said. Emerging Asia and Latin America are the world’s most attractive equity markets because developing economies will grow 5.5 percent this year, about triple the expansion in industrialized nations, she said.

“Emerging-market countries have learned from past crises and have better balance sheets than the developed world,” Kaplan, who helps manage $392 billion at Federated and oversees the global fund, said in an interview yesterday at her office in New York.

The MSCI Emerging Markets Index surged 75 percent last year, the biggest gain since records began in 1988, as financial stimulus programs from China to Brazil helped spur economic growth while the U.S., euro region and Japan contracted. The Shanghai Composite Index rose 80 percent, South Korea’s Kospi index climbed 50 percent and Brazil’s Bovespa index soared 83 percent last year, more than the 30 percent increase for MSCI’s index of developed nations excluding the U.S.

Largest Holdings

The biggest holdings in Kaplan’s InterContinental Fund, which invests exclusively outside the U.S., are the iShares FTSE/Xinhua China 25 Index Fund, an exchange-traded fund that tracks an index of the 25 largest companies in China; South Korea’s Samsung Electronics Co., the world’s second-largest chipmaker; and Brazil’s Vale SA, the world’s largest iron-ore producer. Kaplan’s biggest geographic allocation is China, where she invests 12.1 percent of the fund.

The InterContinental Fund returned an average 8 percent annually over the past five years, better than 89 percent of competitors tracked by Bloomberg. That’s also more than the 5.8 percent average annual return for the MSCI World ex USA Index over the past five years and the 1.5 percent average yearly return for the Standard & Poor’s 500 Index. The MSCI Emerging Markets Index returned 17 percent yearly on average over the same period.

China’s economy probably grew 8.5 percent last year as the U.S. contracted 2.5 percent and the euro region shrank 3.9 percent, according to the median estimates of economists surveyed by Bloomberg.

‘Bubble’ Concerns

MSCI’s emerging-markets measure will probably increase for two more years, and gain 15 percent to 20 percent this year, Kaplan said.

Concerns about a “bubble” in emerging markets are misplaced because demand for Chinese and South Korean exports continues to increase and Latin American countries are benefiting from domestic spending, Kaplan said.

“Emerging markets exhibit higher-quality characteristics compared to developed markets,” she said. “Valuations are still reasonable when compared to the developed world.”

The MSCI Emerging Markets Index trades at 23.1 times the reported earnings of its companies, less than the 29.7 times earnings for the MSCI World Index of 23 developed markets and the S&P 500’s ratio of 24.4, according to Bloomberg data.

‘Excessively Risky’

Kaplan’s fund returned 35 percent last year, more than the 34 percent average of rivals, according to Bloomberg data. It performed worse than competitors in 2008, losing 48 percent for investors amid the first global recession since World War II, compared to a 45 percent loss for rivals.

The fund isn’t investing in Russia, the top investment pick for the biggest emerging-market stock funds in 2010 according to EPFR Global data, because the dangers for investors due to the nation’s corruption problems outweigh benefits, Kaplan said. Russia RTS Index climbed 129 percent last year, the best performance in local currency terms among 95 world market indexes tracked by Bloomberg.

“Russia is seen as excessively risky,” Kaplan said. “We want to make sure that our investors have ownership rights.”

Kaplan is also underweight the U.K. because the country may still be in a recession and is the most likely nation among developed markets to have its credit rating downgraded, she said.

The British government had a 20.3 billion-pound ($33 billion) budget deficit in November, the largest since records began in 1993, pushing national debt above 60 percent of economic output.

“We would like to see some improvement in the country’s fiscal situation,” Kaplan said.