ANNUAL REPORT
TO SHAREHOLDERS
VONTOBEL
EASTERN EUROPEAN EQUITY FUND
A SERIES of
Vontobel Funds, Inc.
a "Series" Investment Company
FOR THE YEAR ENDED
DECEMBER 31, 1996
<PAGE>
VONTOBEL EASTERN EUROPEAN EQUITY FUND - ANNUAL REPORT 1997
Dear Shareholder:
At December 31, the fund's closing Net Asset Value stood at $14.89, producing a
return of 48.9% since the fund's inception on February 15. For the same period,
the Nomura Research Inc. Eastern European Index (ex-Russia) gained 23.9%. During
the second half fund assets quadrupled from $15,012,850 to $61,376,507,
reflecting the region's skyrocketing markets and another strong year of mutual
fund inflows. The fund made no year-end distributions of income and capital
gains.
1996 was a momentous year for investors in Central and Eastern European equities
as the more advanced markets (Hungary, Poland and the Czech Republic)
consolidated their credibility, attracting an estimated flow of US$ 5 billion in
new funds to the region's bourses. Russia, Hungary and Poland ranked among the
world's five top-performing markets, in both local currency and US dollar terms.
Poland, Hungary and the Czech Republic became members of the OECD and moved a
step closer to membership in the European Union sometime early next decade.
Continuing the process of improving their budgetary discipline, they succeeded
in creating a broad band of stability of real exchange rates. They now boast
credit ratings either at or just below investment grade. Russia too was rated
for the first time in its history, and its successful placement of a US$ 1
billion 5-year bond issue in international capital markets underscored the
improved credit standings of Central and Eastern European nations.
Since inception in February 1996, the fund's portfolio holdings have been
concentrated in the three core markets of Central Europe, i.e., Poland, Hungary
and the Czech Republic. At year end these markets represented some 75% of total
portfolio assets. In the second quarter we committed assets to Russia at a time
when pre-election fears rattled the markets. Based on steeply falling inflation
and interest rates and sheer cheapness, the Russian market presented an
attractive investment opportunity, despite political uncertainty and concerns
about President Yeltsin's heart surgery. Our exposure to the Russian market grew
from 5% going into the second quarter 1996 to 16% of portfolio assets at year
end.
During the last quarter we shifted assets from Poland to Hungary, where the
valuations tend to be more attractive. Hungary also offers the largest number of
restructured firms demonstrating strong growth, profitability, generation of
free cash flow and sound financials. We also established a small position in the
nascent Croatian market.
Of the four major markets in which we invest, we are the most cautious about the
the Czech Republic. We are not finding the same quality stocks as are available
elsewhere in the region, valuations are relatively high, and earnings growth
low. Foreign investors are still holding back, waiting for the enactment of
legal changes to improve the transparency of their markets. With many companies
technically bankrupt, Czech banks are burdened with nonperforming loans. In
anticipation of looming problems in the banking sector, we took some profits and
reduced our allocation from 10% to 8% in the second half.
Our investment approach is bottom-up. We search for companies that have
demonstated their ability to consistently generate strong free cash flow, and we
buy them when they are trading
<PAGE>
at substantial discounts to fair value. We like companies that are strong in
both domestic and export markets, that manufacture and sell commercially viable
products and services, and that have experienced, shareholder-oriented
managements. We have found companies meeting these standards primarily in
Hungarian pharmaceutical, construction and bank stocks, as well as in Polish
banks, consumer goods and construction-related issues. In Russia our holdings
are concentrated in energy, utility, telecommunications and oil stocks.
We are focusing increased attention on the markets of Russia, Croatia, Romania,
the Baltics and Ukraine; among the least expensive markets in the world, they
will, we believe, soon outpace the returns of emerging markets in other regions.
As investors become more and more knowledgeable about the region, we expect
liquidity conditions to improve dramatically. Too, as capital inflows increase,
these markets should experience less volatility going forward. Contrariwise, any
dramatic change in the direction of US interest rates might have an adverse
impact on these markets' liquidity, as demonstrated in July when Eastern
European markets sold off on fears of a Fed rate hike. Considering their
performance in the first half, this pause was not unhealthy and in any case was
temporary. The Russian market was notable for its resilience. After selling off
on worries about Yeltsin's health, it recovered by the end of September. As
Russia's economic health improves, and as the regulatory framework for capital
markets strengthens, the market is likely to show a further rise in 1997. For
now, given the lower level of liquidity of the Russian market compared to others
in the region, we are keeping most of our individual positions under 2%. At this
point, we foresee limiting our maximum exposure to this market to 30%. We
reiterate our caution to shareholders that this fund is suitable only for
investors who already have exposure to international equity markets, who are
familiar with the risk of investing in international securities, and,
importantly, who have a long-term horizon.
Despite the spectacular performance of some of these markets last year, the
outlook for Eastern Europe remains bright as earnings growth of 30-35% can be
purchased for an average P/E 97E of below 12X. Eastern European companies will
enjoy greater visibility in international equity portfolios now that Russia has
been added to IFC's Emerging Market Index, and Hungary and the Czech Republic
have joined Poland in Morgan Stanley's Emerging Market Index. The fact that
Russian debt has been rated by four major credit agencies should also help to
increase the comfort level of wary foreign investors. Lastly, monetary and
fiscal policy are restrictive, leading to declining rates of inflation in every
country. The economies of Eastern Europe are at the threshold of a long secular
upswing comparable only to that of Southeast Asia eight years ago.
Arpad Pongracz, CFA
President
January 31, 1997
2
<PAGE>
[GRAPH GOES HERE]
Eastern European Fund EEEI
02/15/96 $10,000.00 $10,000.00
12/31/96 $14,890.00 $12,394.00
3
<PAGE>
SCHEDULE OF PORTFOLIO INVESTMENTS
December 31, 1996
<TABLE>
<CAPTION>
NUMBER MARKET
OF SHARES SECURITY DESCRIPTION VALUE
- ---------- -------------------------------------------------------------------------------- -----------
<S> <C> <C>
COMMON STOCK AND WARRANTS: 93.44%
CROATIA: 3.60%
42,000 Pliva D D GDR Reg S $ 2,226,000
-----------
CZECH REPUBLIC: 8.14%
50,000 Central European Media Class A* 1,587,500
50,000 Ckd Praha Holding AS* 751,921
44,355 Skoda Koncern* 1,573,798
9,000 Spt Telecom AS* 1,120,491
-----------
5,033,710
-----------
HUNGARY: 36.89%
12,100 Cofinec Sponsored GDR 359,975
73,000 Danubius Hotel & Spa* 1,918,677
38,682 Egis Gyogyzergyar 2,259,440
5,000 Gedeon Richter Ltd GDR Reg S 290,000
61,400 Graboplast Rt Regd 2,077,044
2,846 Inter Europa Bank 651,218
150,000 Mol Magyar Olay Es Gazipari Rt 1,873,840
78,500 Otp Bank GDR 1,393,375
7,000 Pannonplast Muanua Reg S 257,576
67,122 Pannonplast Muanyagipari 2,469,857
29,500 Primagaz Hungaria Co Ltd 1,366,450
43,500 Richter Gedeon Vegyeszeti Gyar Rt. 2,542,208
15,700 Scala Ece Ltd. Bearer* 2,182,276
200,000 Tiszai Vegyi Kombinat GDR 2,200,000
23,000 Zalakeramia AG 974,335
-----------
22,816,271
-----------
POLAND: 29.04%
42,000 Agros Holdings Series C* 1,105,880
13,000 Bank Przemyslowo Handlowy 838,739
1,230,000 Big Bank /Bank Inicjatyw G 1,715,840
56,000 Computerland Poland SA* 1,386,622
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
NUMBER MARKET
OF SHARES SECURITY DESCRIPTION VALUE
- ---------- -------------------------------------------------------------------------------- -----------
<S> <C> <C>
110,000 Elektrim SA 997,419
115,716 Exbud SA* 1,069,427
153,570 Mostostal Zabrze-Holding SA 792,647
60,000 Polfa Kunto SA Series A* 1,778,615
225,000 Polifarb Ciesxyn Bearer 1,247,646
177,500 Polifarb Wroclaw Bearer 1,002,825
114,025 Rolimpex SA 886,782
47,000 Stalex Port A Shares* 460,591
18,000 Vilniaus Bankas AB GDR 747,000
300,000 Wielkopolski Bk Kredutwy* 2,029,713
26,000 Zaklady Metali Lekkich* 1,904,164
-----------
17,963,910
-----------
RUSSIA: 15.77%
12,000 AO Mosenergo Spon ADR Reg S 357,000
14,000,000 Credit Suisse Fin Russian Ctf 1,281,000
140,000 Norilsk Nickel Ord. Shs Warrant 11/14/97 721,000
1,500,000 CSFP Certs. Surgutneftegaz Series 3 622,500
210,000 CSFP Certs Rostelekom Series 3 504,000
37 Irkutsken Ergo RDC 1,054,500
23,000 Lukoil Oil Co Sponsored ADR 1,069,500
36,000 Mosenergo AO Spon ADR 1,089,000
29 Rostelecom RDC 696,000
77 Norilisk RDC-ADR shs. 404,250
15 Trading House Gum RDC 420,000
65,000 Vimpel Communications Spon ADR 1,535,625
-----------
9,754,375
-----------
TOTAL COMMON STOCKS AND WARRANTS:
(Cost: $49,991,135) 57,794,266
-----------
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
- ----------
<S> <C> <C>
SHORT TERM INVESTMENTS: 4.20%
$2,600,000 Bank of Tokyo-Mitsubishi; 4.75%; 1/2/97 2,600,000
-----------
TOTAL SHORT TERM INVESTMENTS:
(Cost: $2,600,000) 2,600,000
-----------
TOTAL INVESTMENTS:
(Cost: $52,591,135)** 97.64% 60,394,266
Other assets, net 2.36% 1,458,378
-------- -----------
NET ASSETS 100.00% $61,852,644
-------- -----------
-------- -----------
</TABLE>
*Non-income producing
**Cost for Federal income tax purposes is $52,562,264 and consists of:
<TABLE>
<S> <C> <C>
Gross unrealized appreciation $ 9,422,900
Gross unrealized depreciation (1,590,890)
-----------
Net unrealized appreciation $ 7,832,010
-----------
-----------
</TABLE>
ADR -- Security represented is held by the custodian bank in the form of
American Depository Receipts.
GDR -- Security represented is held by the custodian bank in the form of Global
Depository Receipts.
RDC -- Security represented is held by the custodian bank in the form of Russian
Depository Certificates.
SEE NOTES TO FINANCIAL STATEMENTS
6
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1996
_______________________________________________________________
<TABLE>
<S> <C> <C>
ASSETS
Investments at value (identified cost of $52,591,135)(Notes 1 & 3) $ 60,394,266
Cash (including foreign currencies) 560,594
Receivables
Capital stock sold 1,722,006
Interest 343 1,722,349
----------
Other assets 58,288
------------
TOTAL ASSETS 62,735,497
------------
LIABILITIES
Payables
Securities purchased 826,370
Capital stock redeemed 10,390
Investment management fees 46,093
----------
TOTAL LIABILITIES 882,853
------------
NET ASSETS $ 61,852,644
------------
------------
NET ASSET VALUE, OFFERING AND
REDEMPTION PRICE PER SHARE
($61,852,644 / 4,153,090 shares outstanding) $ 14.89
------------
------------
At December 31, 1996 there were 50,000,000 shares of $.01 par value
stock authorized and the components of net assets are:
Paid in capital $ 55,154,756
Net unrealized gain on investments and currency transactions 7,806,051
Accumulated loss on investments (1,108,163)
------------
Net Assets $ 61,852,644
------------
------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
7
<PAGE>
STATEMENT OF OPERATIONS
February 15* to December 31, 1996
_______________________________________________
<TABLE>
<S> <C> <C>
INVESTMENT INCOME
Income:
Interest $ 343
Dividend (Net of foreign
tax withheld of $7,797) 90,079
Other 63,596
---------
Total income $ 154,018
Expenses:
Investment management fees (Note 2) 302,021
Organization 9,871
Custodian and accounting fees (Note 3) 76,287
Transfer agent fees (Note 2) 16,073
Recordkeeping and administrative services (Note 2) 49,388
Legal and audit fees 2,669
Filing fees and registration (Note 2) 6,330
Shareholder servicing and reports (Note 2) 24,618
Other 3,444
---------
Total expenses 490,701
Custodian fee waiver (76,287)
-----------
Expenses, net 414,414
-----------
Net investment loss (260,396)
-----------
REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS AND FOREIGN CURRENCIES
Net realized loss on investments (1,006,591)
Net realized loss on foreign currencies conversions (50,713)
Net increase in unrealized appreciation on investments and foreign
currencies 7,806,051
-----------
Net gain on investments 6,748,747
-----------
Net increase in net assets resulting from operations $ 6,488,351
-----------
-----------
</TABLE>
*Commencement of operations
SEE NOTES TO FINANCIAL STATEMENTS
8
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
February 15,* to December 31, 1996
______________________________________________
<TABLE>
<S> <C>
OPERATIONS
Net investment loss ($ 260,396)
Net realized (loss) on investments and foreign currencies (1,057,304)
Net unrealized appreciation of investments and currencies 7,806,051
-----------------
Net increase in net assets resulting from operations 6,488,351
CAPITAL SHARE TRANSACTIONS
Net increase in net assets resulting from capital share transactions** 55,364,293
-----------------
Net increase in net assets 61,852,644
Net assets at beginning of period 0
-----------------
NET ASSETS at the end of the period (Includes undistributed net investment income of $0) $61,852,644
-----------------
-----------------
</TABLE>
*Commencement of operations
**A summary of capital share transactions follows:
<TABLE>
<CAPTION>
FEBRUARY 15,* TO
DECEMBER 31, 1996
-------------------------------
SHARES VALUE
--------- -----------------
<S> <C> <C>
Shares sold 5,134,390 $69,104,233
Shares redeemed (981,300) (13,739,940)
--------- -----------------
Net increase 4,153,090 $55,364,293
--------- -----------------
--------- -----------------
</TABLE>
*Commencement of operations
SEE NOTES TO FINANCIAL STATEMENTS
9
<PAGE>
FINANCIAL HIGHLIGHTS
For a Share Outstanding Throughout Each Period
__________________________________
<TABLE>
<CAPTION>
FEBRUARY 15,* TO
DECEMBER 31, 1996
-----------------
<S> <C>
Per Share Operating Performance
Net asset value, beginning of period $ 10.00
-----------------
Income from investment operations-
Net investment loss (0.06)
Net realized and unrealized gain on investments 4.95
-----------------
Total from investment operations 4.89
-----------------
Net asset value, end of period $ 14.89
-----------------
-----------------
Total Return 48.90%
Ratios/Supplemental Data
Net assets, end of period (000's) $61,853
Ratio to average net assets-
Expenses (A) 2.02%**
Expenses-net (B) 1.71%**
Net investment loss (1.07)%**
Portfolio turnover rate 38.69%
Average commission rate paid per share $0.0737
</TABLE>
(A) Expense ratio has been increased to include additional custodian fees which
were offset by custodian fee credits.
(B) Expense ratio-net reflects the effect of the custodian fee credits the fund
received.
*Commencement of operations
**Annualized
SEE NOTES TO FINANCIAL STATEMENTS
10
<PAGE>
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
_______________________________________________________________
NOTE 1-SIGNIFICANT ACCOUNTING POLICIES -- The Vontobel Eastern European Equity
Fund (the "Fund") is a series of Vontobel Funds, Inc. ("VFI") which is
registered under The Investment Company Act of 1940, as amended, as a
diversified open-end management company. The Fund was established in February,
1996 as a series of VFI which has allocated to the Fund 50,000,000 of its
500,000,000 shares of $.01 par value common stock.
The objective of the Fund is to seek to achieve capital appreciation by
investing in a carefully selected and continuously managed diversified portfolio
consisting primarily of equity securities.
The following is a summary of significant accounting policies consistently
followed by the Fund. The policies are in conformity with generally accepted
accounting principles.
A. SECURITY VALUATION. Investments traded on stock exchanges are valued at the
last quoted sales price on the exchange on which the securities are traded as of
the close of business on the last day of the period or, lacking any sales, at
the last available bid price. In cases where securities are traded on more than
one exchange, the securities are valued on the exchange designated by or under
the authority of the Fund's Board of Directors. Securities traded in the
over-the-counter market are valued at the last available sale price in the
over-the-counter market prior to time of valuation. Temporary investments in
U.S. dollar denominated short-term investments are valued at amortized cost,
which approximates market. Portfolio securities which are primarily traded on
foreign exchanges are generally valued at the closing price on the exchange on
which they are traded, and those values are then translated into U.S. dollars at
the current exchange rate.
B. FEDERAL INCOME TAXES. The Fund intends to comply with the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute all of its taxable income to its shareholders. Therefore, no federal
income tax provision is required.
C. SECURITY TRANSACTIONS AND DIVIDENDS. Security transactions are accounted for
on the trade date. The cost of securities sold is determined generally on a
first-in, first-out basis. Dividends are recorded on the ex-dividend date.
11
<PAGE>
D. CURRENCY TRANSLATION. The market values of foreign securities, currency
holdings, other assets and liabilities initially expressed in foreign currencies
are recorded in the financial statements after translation to U.S. dollars based
on the exchange rates at the end of the period. The cost of such holdings is
determined using historical exchange rates. Income and expenses are translated
at approximate rates prevailing when accrued or incurred. Foreign securities and
currency transactions may involve certain considerations and risks not typically
associated with those of domestic origin.
E. DISTRIBUTION TO SHAREHOLDERS. Distribution from investment income and
realized gains, if any, are recorded on the ex-dividend date. Income
distributions and capital gain distributions are determined in accordance with
income tax regulations which may differ from generally accepted accounting
principles. These differences are primarily due to differing treatments for
foreign currency transactions, net operating losses and post-October capital and
currency losses.
F. USE OF ESTIMATES. In preparing financial statements in conformity with
generally accepted accounting principles, management makes estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements, as well as the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates.
NOTE 2-INVESTMENT MANAGEMENT AND DISTRIBUTION AGREEMENTS AND OTHER -- Pursuant
to an Investment Advisory Agreement, the Advisor, Vontobel USA, Inc. ("VUSA")
provides investment services for an annual fee of 1.25% on the first $500
million of average daily net assets and 1.00% on average daily net assets over
$500 million.
VUSA will reimburse the Fund to the extent of its management fee to limit the
Fund's aggregate annual operating expenses (excluding taxes and brokerage
commissions), to the lowest applicable percentage limitation prescribed by any
state in which the Fund's shares are qualified for sale.
As provided in the Administrative Agreement, the Fund reimbursed Commonwealth
Shareholder Services, Inc. ("CSS"), its administrative agent, $80,336 for
providing shareholder services, recordkeeping, administrative services and
blue-sky filings. The Fund compensates CSS for blue-sky and certain shareholder
servicing on an hourly rate basis. For other administrative services, CSS
receives 0.20% of average daily net assets with a minimum fee of $42,500.
12
<PAGE>
Fund Services, Inc. ("FSI") is the Fund's Transfer and Dividend Disbursing
Agent. FSI received $16,073 for its services for the year ended December 31,
1996.
To discourage short term investing and recover certain administrative, transfer
agency, shareholder servicing and other costs associated with such short term
investing, the Fund charges a 2% fee on such redemption of shares held less than
six months. Such fees, net of cost recovery, are included in other income.
Certain officers and/or directors of the Fund are also officers and/or directors
of VUSA, CSS, and FSI.
NOTE 3-INVESTMENTS/CUSTODY -- Purchases and sales of securities other than
short-term notes aggregated $61,394,414 and $10,396,687, respectively. The
custodian has provided credits in the amount of $76,287 against custodian and
accounting charges based on credits on uninvested cash balances of the Fund.
13
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
Vontobel Funds, Incorporated
Richmond, Virginia
We have audited the accompanying statement of assets and liabilities of Vontobel
Eastern European Equity Fund including the schedule of portfolio investments as
of December 31, 1996, and the related statements of operations and changes in
net assets, and the financial highlights for the period February 15, 1996
(commencement of operations) to December 31, 1996. These financial statements
and financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and financial highlights are
free of material misstatements. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of securities owned as of December 31, 1996, by
correspondence with the custodian and brokers. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
Vontobel Eastern European Equity Fund as of December 31, 1996, the results of
its operations, the changes in its net assets, and the financial highlights for
the period February 15, 1996 (commencement of operations) to December 31, 1996,
in conformity with generally accepted accounting principles.
TAIT, WELLER AND BAKER
Philadelphia, Pennsylvania
January 17, 1997
14
<PAGE>
INVESTMENT ADVISOR:
Vontobel USA Inc.
450 Park Avenue
New York, New York 10022
DISTRIBUTOR:
First Dominion Capital Corp.
1500 Forest Avenue
Suite 223
Richmond, Virginia 23229
INDEPENDENT AUDITORS:
Tait, Weller and Baker
Two Penn Center, Suite 700
Philadelphia, Pennsylvania 19102-1707
TRANSFER AGENT:
For account information, wire purchase or redemptions, call or write to
Vontobel's Transfer Agent:
Fund Services, Inc.
Post Office Box 26305
Richmond, Virginia 23260
(800) 628-4077 Toll Free
MORE INFORMATION:
For 24 hour, 7 days a week price information, and for information on any
series of Vontobel Funds, Inc., investment plans, and other shareholder
services, call Commonwealth Shareholder Services at (800) 527-9500 Toll Free
NASDAQ SYMBOL: VEEEX
