* Bond investors spread risk in emerging markets
* Opportunity seen in German, Swiss ETFs and some stocks
* Two-year Greek, Spanish debt seen as risky
* Some investors attracted by double-digit yields
By Aaron Pressman
BOSTON, April 5 Europe's frayed economic union is being hit at regular intervals by bad news from its 'fringe' members.
Once-stalwart countries like Ireland and Spain moved to that edge last year and their rehabbing is far from complete.
In the latest bad news, Moody's and Standard & Poor's cut Portugal's debt ratings after the country last week said it would not meet its budget deficit target and set new elections for June.[ID:nLDE7340WP]
European stocks have pulled back sharply in recent months, before rebounding. Bond prices have fallen, and yields have soared to double digits in some cases.
For investors, the lure of big returns might be too much to resist -- but the chance of a default keeps many away. One market indicator, the level of credit default swaps, is flashing a 40 percent chance that one will happen in Portugal within five years.
For investors looking for ways to diversify into Europe, there are safer ways to play. With all of the bad news slamming the markets, Europe does offer some bargains, analysts say, and there are ways to get in without excessive risk.
EUROPE EQUITY FUNDS
Concentrating on a few countries via Exchange Traded Funds may be a smarter way to go than buying a broad European ETF. according to analyst Carlos Alexandre at CXA Markets in Dallas.
His top picks are the iShares MSCI Germany Index Fund (EWG.P) and the iShares MSCI Switzerland Index Fund (EWL.P).
"The German economy, despite being somewhat joined at the hip with the rest of the Euro zone, will inevitably benefit from capital flows," Alexandre said. The country still benefits from "the perception of future earnings strength and safety."
The big German ETF dropped as low as $23.02 last month, an 11 percent fall from the end of February. But the fund has since recovered and, at $26.38, is 1 percent higher than the end of February.
Switzerland is somewhat shielded from Euro problems because it is not part of the single currency system, Alexandre said. The Swiss ETF fell 8 percent om March but recouped it quickly.
INDIVIDUAL STOCK PLAYS
Even those who see Europe as a place with problems say there are attractive stocks in the region.
"So many people have the view that Europe is over and done," David Marcus, manager of the Evermore Global Value Fund, said. "There are real problems and the countries have issues -- but specific companies are opportunities."
German manufacturing conglomerate Siemens AG (SIEGn.DE), for example, will benefit from savvy cost-cutting and a restructuring of its industrial unit, Marcus said. And revenue is rapidly growing outside of Europe. Yet the stock gyrated between almost 100 euros and under 85 euros in March.
Because of Europe's strong exports focus, investors can find companies that generate much of their income abroad, notes Michael Kass, manager of the Baron International Growth Fund (BIGFX.O).
Compagnie Financiere Richemont SA (CFR.VX), which owns the Cartier watch brand, is one example from outside Europe if tourists buying in European stores are included, Kass said.
"This is a high returns business that is not something you can replicate elsewhere," he said. Standard Chartered Plc (STAN.L), the global banker whose network spans much of Britain's once-vast empire, does most of its business abroad, Kass said.
With bonds in much of the world yielding micro-returns, the chance to lock in 10-percent plus from a developed country does not often arise.
The problem is that this 'lock' is not very secure.
Some aggressive investors are loading up on high yielding two-year bonds from Greece and Spain. The logic is that those countries have engineered their finances to stave off cash shortfalls the next three years, says Kevin Flanagan, chief fixed income strategist at Morgan Stanley Smith Barney in Purchase, N.Y.
"But you have to have a cast iron stomach for that trade," he said. "We would stay away from peripheral Europe and I wouldn't look at core Europe as much of an opportunity either."
No one is racing to buy Portugal's debt. On Tuesday, after Moody's downgrade, yields hit an all-time high since the creation of the euro at over 9 percent and most expect a double digit level soon. The country's own banks said they were considering boycotting the bonds until a bailout comes, according to Portuguese news reports.
Still there are many very safe credits in Europe, and most do not have the fiscal problems of the fringe economies.
"With the dollar depreciating and the backing of China, Europe's bonds right now may be attractive," said Greg Peterson, director of investment research at Ballentine Partners in Waltham, Mass. "And they yield more than U.S. bonds."
EMERGING MARKET BOND ETFs
The Euro-crisis has tended to boost bond yields of all emerging markets, since their prices tend to move as if they are all part of the same asset class. As a result, funds that invest in Latin American and Asian emerging market debt have better yields with less risk than the European markets, Flanagan said.
Among ETFs, the $2 billion the iShares JPMorgan US Dollar Emerging Markets Bond Fund (EMB.P) and $900 million PowerShares Emerging Markets Sovereign Debt Fund (PCY.P) are two of the largest. The iShare fund has an expense ratio of 0.6 percent compared to 0.5 percent for Powershares.
However, in a fast changing market, the bond ETFs must stay within its specified list of holdings. With markets volatile, Ballentine's Peterson says, funds that are actively managed might be better placed to sidestep credit minefields.
MANAGING WITHOUT EUROPE
Some global players are just staying out of the Euro-space.
One of the top-performing actively-managed funds over the past 10 years that invests globally is the Loomis Sayles Bond Fund (LSBRX.O) which has gained almost 10 percent a year over that period.
The fund had only a small allocation to Europe as of the end of February, its most recent disclosure. About 3.6 percent of the fund was in debt of Norway, 2 percent in bonds from Ireland and 1 percent in bonds of the United Kingdom.
"Ireland has an extremely dynamic economy with fewer of the labor market constraints than other parts of Europe," Loomis Sayles sovereign analyst Laura Sarlo said.
The $50 billion Templeton Global Bond Fund (TPINX.O), which has gained 11 percent a year over the past decade, is also staying away from most European debt. It had only 1 percent of its assets in members of the European Monetary Union at the end of 2010.
"We remain defensive towards European bonds due to a rising interest rate environment and the ongoing problems in the periphery," David Zahn, senior vice president for Franklin Templeton in London, said. (Reporting by Aaron Pressman) (Editing by Richard Satran and Chelsea Emery)