A Peripheral Challenge

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For Spanish supermarket chain Superdiplo, 1999 was a bullish year. The Spanish economy was vibrant and Superdiplo's net profits for the nine-month period of January-September 1999 totaled $35.8 million, a 76% increase over the same period last year. Yet for all of its successes and prospects, Superdiplo's share price has been gored, down about 30% from its January high of around $23. "It's very frustrating and it's not justified," moans spokesman Lacalle Gonzalo.

He's right. Superdiplo's share price doldrums have nothing to do with its balance sheet, and everything to do with an unintended side effect of Europe's new single currency. Superdiplo--and hundreds of other companies that list on some of Europe's peripheral stock markets--have been hit by a euro-induced dash for the exits by institutional investors even though their local economies are booming.

In recent years the Spanish, Portuguese, Italian and Irish markets benefited as domestic fund managers filled their portfolios with homegrown stocks as a hedge against currency risks. That bias allowed well-performing companies like Superdiplo to be big fish in the relatively small ponds of Europe's fringe markets. But currency risks evaporated with the advent of the euro last January. And now the big funds in these countries are ditching domestic markets and companies for Euroland's larger, more liquid bourses--and the well-known, large-cap stocks that list on those exchanges.

Numbers tell the story. Last December, 90% of the capital managed by Portuguese equity funds sat in domestic shares; that figure has now slipped to 60%. The number of Irish stocks in the average Irish fund portfolio will be halved by early 2000. The decline in demand has pushed stock prices lower. Lehman Brothers calculates that Portugal's stock market has underperformed a leading Euroland benchmark by 24% this year, Spain's by 9%, Italy's by 9% and Ireland's by 14%. And most of the blame goes to the proclivity of fund managers to reweight their portfolios.

All four of those bourses were highflyers in the two-year run-up to the euro. Back then, country-level analyses were popular with investors and the exchanges benefited from being in countries experiencing rapid growth. Now, investors are increasingly picking stocks by sector. In that methodology, size matters and only the largest players in each sector tend to benefit. Indeed, most funds try to mimic the various large-cap indices, like the Dow Jones Euro Stoxx 50. "You need to be a company linked to an index, but Superdiplo is not," Gonzalo explains. "If you are not in an index, you're nowhere."

Indexing has meant that small- to medium-cap stocks have been particularly hard hit in fringe markets. But even larger, strong-performing companies like Portugal Telecom and Ireland's two big banks, Allied Irish Bank and Bank of Ireland, have been whacked. Since January, Portugal Telecom's stock is down 20%, AIB's 15% and Bank of Ireland's 24%. AIB was further hobbled in September when it lost its place on the Stoxx 50. "It just wasn't big enough," says Jim Power, chief economist at the Bank of Ireland.

This capital flight from secondary markets wasn't entirely unexpected, but local firms hoped that foreign investors would fill the vacuum. That hasn't happened because of fund managers' fixation with indices and big brands. "That has caught people wrong-footed," Power admits. But Teun Draaisma, European markets analyst at Morgan Stanley Dean Witter, says the fascination with global brands is easy to explain: "They're big and easy and liquid." One huge, blue-chip company can make a difference in a fringe market. Half of Helsinki's market capitalization comes from mobile phone highflyer Nokia. As a result, the Finnish bourse is up 40% this year, essentially riding Nokia's coattails.

So, will investors return? It's possible that by mid-2000 fund managers in Europe's bigger markets will rebenchmark their portfolios, leading some of them back to smaller exchanges. And bargain-hunting may help as well. Analysts claim there are outstanding opportunities in these markets for investors willing to seek them out.

But shares in small- and medium-cap companies may still go begging for institutional investors. That could lead some cash-strapped companies to leave the equity markets for bonds. And as the likelihood of an electronic, pan-European market grows ever greater, if the present disinvestment trend continues, several fringe exchanges could face extinction. "Obviously I worry about that, because I would be out of work," says Diego Hernando, head of research at BBV-Midas in Lisbon. "But there is always room for niche players," small national markets catering to local companies and investors. However, such markets may struggle to maintain enough liquidity to survive.

Meanwhile, a lot of Europe's small, public companies are resigning themselves to underperforming shares for some time to come. "What can you do?" Superdiplo's Gonzalo sighs. "Keep producing better results and hope someone notices."