It started with a Goldman Sachs paper that popularized the term BRIC, referring to the emerging markets of Brazil, Russia, India and China. The paper projected that by 2040 the combined BRIC economies will be larger than the developed economies of the US, Japan, UK, Germany, France and Italy. BRICs would have remained nothing more than a catchy concept but the subsequent eye-popping stock market returns in these countries led to a predictable result: the fund industry is churning out products to ride the trend and investors seem to be chasing returns. Over the past five years, Brazil, Russia, China and India have returned 52*, 30%, 22%, 35% respectively (in US dollar terms) compared to 7% for the S&P 500.
A frequent justification for investing in BRICs is the rapid GDP growth experienced by these economies. However, in this article, William Bernstein advises caution in inferring stock market returns from economic growth pointing out that if anything, there seems to be negative relationship between growth and returns. Bernstein also notes the paucity of data on risk / return characteristics of emerging markets in general, never mind the BRIC markets.
Another reason for caution is the sorry history of foreign investing “concepts” — Japan in the eighties and the Asian Tigers in the nineties. Is there any reason to believe that this time will be different?
BRICs do have a role in a portfolio — as a part of a broad emerging market holding such as the Vanguard Emerging Market ETF (VWO). But there is no reason to believe that an allocation higher than their 5.4% weighting in the world stock market is warranted.
* Using iShares MSCI Brazil ETF (EWZ), Templeton Russia & East Europe Fund (TRF), China Fund (CHN) and India Fund (IFN) as a proxy for the Brazil, Russia, China and India markets respectively.
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16 responses so far ↓
1 WhereDoesAllMyMoneyGo.com // Aug 25, 2008 at 12:14 am
According to data from Bespoke, BRIC nations are now 12.1% of the world’s market cap. With the recent woes in the US, their share has fallen to 29.9% (!). (Data as of June/2008)
2 Charles // Aug 25, 2008 at 3:19 am
I also worry as an ethical investor that I really have no clear way of understanding the implications of my investments in such emerging market countries. China supports Sudan financially and Russia has recently engaged a small neighbouring country in a bloody conflict. My stomach would have been upside down if I held a BRIC fund.
This is why I’m waiting for a good low-fee index ETF that applies some sort of social/ethical/sustainability screen to worldwide markets. My international equity portion is currently in EFA but I have promised myself that I will strongly consider shifting to a cheap enough screened fund once there’s something I’m able to buy.
The Dow Jones Global Sustainability Index is already tracked by at least one US mutual fund but no ETFs so Canadians can’t buy it. TD has a mutual fund that uses this index as a benchmark but the MER is way too high. Pax World came to an agreement this year with KLD to create ETFs for their sustainability indexes but so far these products haven’t appeared.
3 Canadian Capitalist // Aug 25, 2008 at 10:02 am
Preet: I believe you are referring to this post on Bespoke:
http://bespokeinvest.typepad.com/bespoke/2008/06/percent-of-worl.html
I’m not sure how they are calculating market capitalization but I’m guessing that it is not float-adjusted. When not adjusted for float, market capitalization does not reflect assets that are truly investable. The percentages I quoted in this post are for the FTSE All-World Index.
Charles: Larry MacDonald wrote a recent article on SRI in the Globe and Mail. I’ll see if I can dig it up.
4 laketrout // Aug 25, 2008 at 10:21 am
There’s also Claymore’s BRIC ETF (CBQ) that trades on the TSX.
http://tinyurl.com/2d8rgq
Also, for reference, BRIC countries currently make up 5.12% of the global market cap while total Emerging Markets (which an ETF such as VWO tracks) makes up 9.97% of the global market cap.
http://tinyurl.com/6ybrfz
5 WhereDoesAllMyMoneyGo.com // Aug 25, 2008 at 10:31 am
Yes, I believe you are correct in that they are not using free-float numbers. Which adds another consideration into your analysis. The US has a free float of 90%+ and China’s is closer to 20%. Adjusting for float, and the US is down to around 41% (as opposed to 30% non-float adjusted).
There is a difference in pricing between the dual share classes of the same issuers in China - I’ll see if I can dig up that paper. Also, it is interesting to note that DFA does not invest in Russia at all (they cited that contract enforcement is too sketchy and this adds risk that they don’t feel investors are adequately compensated for). So in other words, there are other reasons that warrant caution when it comes to emerging markets!
6 Charles // Aug 25, 2008 at 10:42 am
Canadian Capitalist: Yep I’ve read most of the SRI articles that come out.
The trouble with SRI firms right now in Canada is that they’re stuck in the land of “old school” mutual funds with fees comparable to the median of their classes. Which is understandable, but unacceptable to me. I might pay a small premium (like 0.50% instead of 0.25%) for an SRI equity fund - which is why I’m invested in XEN and KLD - but I won’t pay what Ethical Funds, PH&N or Meritas charges for their SRI international funds. So for now I’m buggered in the international equity category.
7 LittleMoneyLab // Aug 25, 2008 at 10:48 am
CBQ is too expensive, a MER at 0.6%. Also, CBQ is not as diversified as VWO. I think VWO is a better choice.
8 NN // Aug 25, 2008 at 11:27 am
Buying into specialized BRIC funds is chasing past performance, and hopefully no regular reader of this blog considers doing that. The case for emerging markets in general is different - there are some good opportunities outside the BRIC nations (Africa, for instance. It may not be too long before the marketing departments at Vanguard et al start churning out EZRA funds [Egypt-Zimbabwe-Rwanda-Algeria]).
Charles, you raise a good point. However, unethical companies operate out of all markets (Halliburton, for example). What reason is there to believe that a screen for SRI is adequate? An ETF administrator needs to minimixe costs - hardly an incentive to do extensive SRI research. I believe the only way to be sure you are investing in ethical companies is to do your own research, but you won’t construct a ’sleepy portfolio’ that way….
9 Dividend Growth Investor // Aug 25, 2008 at 12:24 pm
I am always hesitant about “catchy” investment phrases like Nifty-fifty, bricks and clicks, and BRIC.
It makes me want to do some short selling.
10 Charles // Aug 25, 2008 at 1:45 pm
NN, of course you have a good point too - but remember that an ETF or mutual fund following an SRI index does not need to do their own research. They’re paying for it via license fees, but it doesn’t have to cost that much. For example, the US mutual fund VFTSX follows the FTSE4Good US Select index and has an MER of 0.24%. I would gladly spring for that if I were allowed to. And iShares in Germany has the “iShares DJ EURO STOXX Sustainability 40″ ETF with an MER of 0.42%.
I do realize that SRI decisions made by a fundco or index provider may not be totally ideal compared to my own standards, but it still excludes the worst from the pack. For example I own no share in Halliburton because my US equity is invested in KLD which excludes that company. In any case I feel like Western-world unethical companies are “the devil I know”, and developing-world unethical companies are an entirely different breed that scares me.
11 ThickenMyWallet // Aug 25, 2008 at 2:16 pm
What’s often over-looked in emerging markets is there are no real rules to protect the shareholder. Disclosure is, relatively speaking, a laughable concept, regulators don’t want to kill the golden goose so they let A LOT go and standardized accounting rules are merely optional and Enron type accounting scandals can be daily practices. The allocation you suggest is prudent given these risk factors.
12 Phil S // Aug 25, 2008 at 6:19 pm
It’s kind of a no-brainer that BRIC must do well, as just China and India alone have half of the entire world’s population and they are working hard to bring themselves out of poverty.
My problem with China is that it is a communist country and they can make decisions which affect foreign capital on a whim. India’s market is a very protected market as well, as foreign investors cannot invest directly in the country. If you look at some of the funds that invest in India, they have to set up some bizarre money laundering scheme involving setting up offshore corporations owned by Indian nationals to hold all of those investments and stuff. If India’s government closes all of these loopholes, they can just confiscate all of your money because it was an illegal entity to begin with. And don’t get me started with all of the corruption and the oligarchy in Russia.
Brazil, on the other hand, is making amazing economic reforms and strides ahead since their currency crisis of near a decade ago.
So, my advice is to invest overseas with great care. Even if you’re investing in a developed country like Germany - do you have any idea if their companies follow international GAAP? And if not, how can you equate their P/E ratios to ours, as their Earnings are likely not calculated the same way… Our own accounting of assets is very dubious in nature - what do you suppose their balance sheet looks like?
13 Blogging About Money // Aug 25, 2008 at 10:03 pm
Other considerations when investing in BRIC countries include evaluating the rule of law in each of these countries. In India and China, land ownership rules are so lax or non-existent, that corporations can experience great expenses setting up shop only to be forced to relocate a few months later. Russia has shown that they are unafraid to nationalize public companies’ assets.
Another consideration is the immature nature of each BRIC countries’ public stock exchanges. While providing ample opportunities to find grossly undervalued companies, one can also encounter gross price manipulation, fluctuations or any of a number of adverse results that can destroy value in one’s portfolio.
Wouldn’t it be simply better to find great Western companies that have been able to penetrate these emerging giants for their future growth, like Coca-Cola, Pepsi, Johnson & Johnson, General Electric, et. al.? Seems to me that these companies will profit as much, if not more than most local publicly traded companies.
14 Big Winner // Aug 25, 2008 at 10:19 pm
In 2004, US stocks were 40% of the total equities in the world, and now they are only 29%. It seems as if this trend will continue, with the non-USA world getting an even larger slice of the pie.
15 Ron Robins // Aug 27, 2008 at 11:02 am
I see a number of comments referring to ethical investments.
For anyone interested I have a Canadian site that covers the latest global news and research on ethical investing. It’s at http://investingforthesoul.com/
Best wishes, Ron Robins
16 Weekly Roundup: Laboring All Day Edition at Clever Dude Personal Finance & Money // Sep 1, 2008 at 3:46 pm
[...] Capitalist questions whether BRICs belong in your portfolio. If you’re wondering, BRIC stands for the emergins markets of Brazil, Russia, India and [...]
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