Buy BRIC to Weather the Storm
BRIC is an acronym for Brazil, Russia, India and China and was coined by Goldman Sachs in their global economics paper “Building Better Global Economic BRIC’s” in 2001. By 2007 GS were able to write:
“Since then, these countries. equity markets have seen a remarkable increase in their value: Brazil has risen by 369%, India by 499%, Russia by 630%, and China by 201%, using the A-share market, or by a stunning 817% based on the HSCEI. The equity market performance is just one manifestation of the staggering rise in BRIC’s importance to the global economy. In our 2001 paper, we argued that the BRIC economies would make up more than 10% of world GDP by the end of this decade. In fact, as we near the end of 2007, their combined weight is already 15% of the global economy.”1
The BRIC countries were selected for specific analysis because they share the following attributes:
- They are the largest and fastest growing of the “emerging” economies.
- They have massive populations and are experiencing rapid growth in levels of urbanization, industrialization, national and personal incomes, infrastructure development, capital market development, etc.
- They enjoy massive stores of natural resources (Brazil, Russia) or they are massive users of natural resources (China, India).
- As a result of these attributes, they are supplanting developed nations rankings in world GDP, eg. its likely that by 2040 China will have overtaken the US as the world’s largest economy.
For those interested in the detail of the BRIC “dream” there is detailed material available on the Goldman Sachs “BRIC” website (http://www2.goldmansachs.com/ideas/brics/brics-dream.html ) and also at Wikipedia (http://en.wikipedia.org/wiki/BRIC ). Goldmans predict that China and India will become the dominant providers of manufactured goods and services in the world, and that Brazil and Russia will become the dominant providers of natural resources.
Clearly, any rationally constructed investment portfolio will have meaningful exposure to the BRIC sector – and will beware of retaining for too long, exposure to countries and company’s which are being displaced by BRIC activity. In the next Part we look at how to avoid the danger of under-investment in BRIC and over-investment in the developed nations.
We can illustrate the key benefits and risks of BRIC investing by various economic data: in figure 1 below we see that although the BRIC economies are part of – and therefore prone to the same cycles as – the global economy, they remain more resilient than the G3 nations:
Although Russia and Brazil have experienced negative GDP growth as a result of the GFC (weathered by China and India largely through domestic expenditure), by next year (2010) all 4 of the BRIC economies are predicted to return to positive GDP growth:
Key factors which have impacted the BRIC country’s ability to weather the GFC include:
- Population size (larger populations of the BRIC countries relative to smaller emerging economies drive domestic demand as a buffer to falling demand for exports);
- Degree of openness of domestic economies (each of the BRIC economies has a relatively closed economy and can thus better control responses to the GFC);
- Reliance on commodity exports (here, Russia and Brazil are faring economically worse than China and India, although as energy prices rebound, Russia’s economy will grow, too);
- Level of reliance on external capital (China’s massive foreign currency reserves have helped it maintain strong economic growth, stimulated by government spending).
Taking these factors into account, China and India are currently best placed to weather the global economic storm, whilst Brazil and Russia will return to positive GDP growth as a result of the recovery in the global economy and resource prices.
China is expected to grow at 7% to 8% in 2009 and 7.5% to 9.5% in 2010:
Most investors are familiar with the frequent underperformance of actively managed investment funds. Compared to their reference benchmarks (eg. in Australia, most active equity fund managers are benchmarked against the S&P/ASX 200 index), median fund managers underperform more often than not. Fees are one factor, high turnover is another: since the methodology of benchmark aware fund managers relies on closely replicating the moves of the reference benchmark (with slight “bets” above or below the movements of the index), these managers are forced to sell shares when the market falls, and to buy shares when it rises again. This locks in losses in falling markets and generates tax liabilities as markets rise and fall.
Many investors seek to avoid these problems by investing in low turnover, concentrated share portfolios, with “direct” share investing a clear preference for many DIY Australian investors. Index investing is another popular way to avoid the problems of active funds. It’s virtually impossible to replicate the direct investing approach for international and especially emerging markets, such as BRIC. Intending BRIC investors are thus faced with the choice of either using an actively managed share fund, either one offering broad based international equity exposure, or one offering specific emerging market or BRIC exposure. For investors seeking pure BRIC exposure, indices such as the Standard & Poor’s “BRIC 40” index offers some attraction. There are specific investments available to Australian investors offering exposure to the S&P BRIC 40 Index.
The S&P BRIC 40 Index is compiled by S&P with a specific methodology, which is documented and available for review at the S&P BRIC 40 website: http://www2.standardandpoors.com, search for “BRIC.”
The methodology seeks to provide returns in line with the overall market performance of the 4 constituents, ie. the market “beta.” In turn, this index approach recognizes that it is hard consistently to outperform equity markets, especially in relatively illiquid markets like those of the BRIC sector. S&P summarise the methodology as follows:
“The S&P BRIC 40 index is designed to offer exposure to four emerging markets: Brazil, Russia, India, and China. Brazil, Russia, India, and China have together been known as the BRIC countries. They are actively watched by investors in recognition of their potential to move from emerging market status to developed market. The index includes 40 leading companies from these four countries. All constituents trade in developed market exchanges (Hong Kong Stock Exchange, London Stock Exchange, NASDAQ, and NYSE) …
Universe. All constituents of the S&P/IFCI indices for Brazil, Russia, India, and China comprise the starting universe.
Listing. Stocks in the starting universe that do not have a developed market listing are removed.
Public Float. All stocks with a float adjusted market cap less than the “Market Cap Threshold” and/or average three month daily value traded less than the “Liquidity Threshold” are removed. Currently, the Market Cap Threshold is US$1 billion and the Liquidity Threshold is US$5 million.
Multiple Share Classes. If a stock has multiple share classes, the share class with lower liquidity is removed.
Final Index Membership. Remaining stocks are sorted in decreasing order of their market cap. The top forty become index members.”
(http://www2.standardandpoors.com/spf/pdf/index/SP_BRIC_40_Factsheet.pdf)
The S &P BRIC 40 Index has fallen sharply from its highs but has rebounded as global economic recovery proceeds:
Australian investors will normally benefit from using investments over the S&P BRIC 40 index which offer protection against FX movements, and should also carefully consider using capital protected investments – this allows the investor to gain exposure to the growth potential of the BRIC sector but to avoid the inevitable volatility of equity markets which may well be magnified in emerging markets like the BRIC sector.
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