Sink or swim with Europe's new boys

Should investors dive in as Bulgaria and Romania join the burgeoning ranks on the EU's Eastern front?

Next up, Bulgaria and Romania. On New Year's Day, the two Eastern European states will formally join the EU. They'll be added to the 10-strong gang of "accession" countries - including the Czech Republic, Hungary, Poland, Slovakia and Slovenia - that joined in 2004.

Like the others, Bulgaria and Romania won't adopt the euro until they pass economic tests such as low inflation, stable interest rates and steady growth.

In the meantime, individual investors yet to tap into their annual £7,000 individual savings account (ISA) allowance might view the EU new boys and their neighbours as an opportunity for high returns - that is, if they're prepared to chance their arms.

Many of the accession countries' economies took off just before and after they joined the EU, largely on the back of a flood of cash from overseas companies keen to exploit the potential of these new markets.

But a recent bout of volatility has cast doubts on whether the stellar growth can continue.

"It's volatile, and as some of the countries might not have the kind of corporate governance seen in more established European members, it can also be unpredictable," warns Darius McDermott of discount broker Chelsea Financial Services. "But it presents fantastic opportunities rarely found in the European old guard."

For example, he explains, many companies are desperate to outsource work - whether manufacturing or marketing - from costly Western Europe to the cheaper East. So funds that back these companies could turn your investment into big gains.

Fund managers are trying to exploit rising consumer demand, too, for the pay packets of the millions of workers in new jobs have to go somewhere. "Retail sales receipts for Central Europe were up 11.5 per cent in July on the year before," adds Mr McDermott.

That's the upside. The downside is the potential risk, and that has become more pronounced recently due to concern over US interest rate rises and tumbling prices for commodities like copper and nickel.

Higher US rates - they currently stand at 5 per cent - often spread round the world due to America's huge economic influence. More expensive borrowing for businesses, and governments, then translates into slower growth and job creation and eats into profits. That in turn affects stock markets and, ultimately, your investment fund.

As for the impact of lower commodity prices, a large number of industries in the "new" EU are heavily geared towards the metals. As a result, earnings and share prices are down.

And don't forget political risk - witness the riots after the Hungarian Prime Minister's recent admission of lying to the public to win the general election in April.

To provide some investment perspective, if you had put £1,000 into JPMorgan Fleming New Europe Income five years ago, you would have £4,427 today, says ratings agency Standard & Poor's. Similarly, a £1,000 lump sum deposited in Credit Suisse European Frontiers in October 2001 would have grown to £4,376.

Compare this with £1,000 invested in the average-performing UK unit trust: your original money would have grown to just £1,490.

More recently, though, the contrast has been much less marked. Over a one-year period, the emerging Europe funds of JPMorgan, Credit Suisse and Jupiter would, on average, have turned £1,000 into £1,085. That compares with £1,052 from UK unit trusts. "The sort of growth we have seen in recent years is not sustainable," warns Elizabeth Eaton, manager of Credit Suisse European Frontiers.

However, Philip Pearson of independent financial adviser P&P Invest says: "These economies could offer the best opportunities for growth over the next 10 years, and investing now in the early stages could reap significant benefits."