Market Watch : European Funds Will Be Hot Spots in Decade Ahead : Investing: With walls falling between East and West, investors are hoping to gain from burgeoning cross-border business.

Until recently, if an East German woman wanted to use birth control pills, her only choice was a drug that was banned in the West 20 years ago because it was so toxic. That has changed.

After the fall of the Berlin Wall, Schering AG, a West Berlin-based pharmaceutical company, introduced a safer oral contraceptive to its Eastern neighbors. Women got a better pill, and Schering’s sales rose 30%.

The company’s success is only one of countless examples of why U.S.-based mutual funds are investing in Western European markets as if they were tourists with unlimited expense accounts. There are already at least 16 various types of European funds, many of which are less than a year old, with several more on the way, said W. Douglas Dent, co-editor of Frank Cappiello’s Closed-End Fund Digest.

With the ideological and physical walls falling between East and West and the coming of a united marketplace in Western Europe in 1992, investors are hoping to take advantage of blossoming cross-border business. This optimism helped boost the performance of European funds into second place last year among all mutual fund groups, trailing only funds investing in Asia, Dent said.

“There are going to be hiccups, but the general trend is certainly going to be up,” said S. Juliet Cohn, European portfolio manager for Kleinwort Benson International Equity Fund.

But some experts note that not all funds will be successful. Profitable funds will need to invest in the right countries and companies, at the right time.

For example, until recently, West Germany was the favorite of U.S. mutual funds. But several experts said the German mutual fund market is overcrowded. Four so-called single-country funds--those that invest in stocks of companies from one country only--already target West Germany, and another is on the way.

Furthermore, securities’ prices are still rising there, so fund managers are casting about for undervalued markets in other parts of Europe.

So far investors are divided on what country will emerge as the next big payoff because each region offers its own benefits and pitfalls. “All of the countries in Europe will benefit, but pinning it on one sector is difficult,” said Christian Wignall, chief investment officer for GT Global Funds.

Ten single-country funds have already blanketed most of Europe, from Ireland to Italy and Portugal to Austria. Greece, France and a fourth fund for Spain are coming. Western Europe is also covered by three regional and three global funds, with new ones in the making, Dent said.

But European mutual funds are not without risk. Tremendous demand, particularly for closed-end single-country funds, sent premiums soaring in the dawning days of the new year. But the values plummeted in mid-January. (Closed-end funds sell only a set number of shares to investors, and thus the prices of their shares rise and fall, selling at either a premium or a discount against the value of their portfolios. Their shares are sold on stock exchanges or over the counter.)

“As far as single-country funds, that group was very overvalued coming into the term,” said Thomas J. Herzfeld, a fund market analyst in Miami. On average, if you invested $2,000 in a European single-country fund on Jan. 1, it was worth an extra $248 11 days later. But by April 6, it was valued at only $1,676.

Several analysts said they’re recommending against single-country funds precisely because they’re so volatile. Instead, they prefer regional or global funds.

They also advise that fund managers should pick securities based more on the prospects of individual companies than the countries from which they originate. “There are some (fund managers) who are just investing blanketly. I don’t believe that’s the way to go about it,” Cohn said.

So what do fund managers have their eyes on? Many say the best bets are companies that offer services needed in Eastern Europe or that will benefit from a united European Community. And if the companies are located in countries with more liberal economies, so much the better.

Wignall says he’s keen on French hotels and General des Eaux, a French water utility company that’s expanding into telecommunications and pollution control. He’s also enthusiastic about a company called Corticeira Amorim, Portugal’s largest cork manufacturer. Cork is a major industry for Portugal, and if Europe continues to prosper, there will be plenty of cause to pop open numerous bottles of champagne.

Cohn said construction companies with access to rebuilding Eastern Europe are good picks, as are the shipping and transportation industries, which will see increased demand to move people and goods across once-restricted borders.

Although not bullish on the entire Italian economy, Cohn said several companies there with strong ties to the Soviet Union should prosper. Fiat, for instance, is building an automobile plant 620 miles southeast of Moscow with the help of Soviet grants.

Still, there are fund managers who are eyeing entire regions. Several investors said the Mediterranean countries will do well because they offer relatively inexpensive labor pools. A fourth single-country fund is about to invest in Spain, and other upcoming funds are set to invest in Greece and France. Italy, Portugal and even Turkey already have funds.

Cohn said many investors are rushing to the Netherlands because of its undervalued stock market. And she predicts that despite concerns of inflation in West Germany, many companies there will do well because of their close proximity to Eastern Europe. Amid all the European euphoria, however, there will be losers. Companies will fail and regions will falter.

“There are going to be some companies that get their fingers burned or that just get there too late,” Cohn said.

Dent is particularly worried about the fragility of Eastern Europe’s emerging political and economic system. That’s why he’s recommending another region.

“The American market may be the best place to be,” he said. “I think people feel more comfortable here.”