Emerging Markets: Is the BRIC fairytale over?

WHEN it comes to the emerging market story, key players in the tale are the so-called BRIC economies.

The fast-growing economies of Brazil, Russia, India and China and their combined population of 2.8 billion people were portrayed as the heroes of a narrative that had investors around the world enchanted.

It was a great story to sell to investors and an easy-to-use marketing term that encapsulated the strong growth occurring outside developed markets.

The enthusiasm for the BRIC group even saw many investors only make allocations to these four countries, rather than taking the plunge with a broad emerging markets approach.

According to Investopedia, the term ‘emerging markets’ was coined in 1981 by Antoine W Van Agtmael of the International Finance Corporation of the World Bank to describe a group of economies with low-to-middle per capita income. These countries constitute approximately 80 per cent of the global population and represent about 20 per cent of the world’s economies.

The group of emerging market economies represents about 25 countries, with the BRIC group representing only a segment of the total asset class, according to HSBC Bank Australia head of funds and investments Charles Genocchio.

“In principle it was easy to lump them together,” he explained.

Principal Global Investors chief executive Grant Forster agrees BRIC is not the same as the broader emerging markets asset class. “BRIC is a more concentrated subset of emerging markets.”

While for several years taking this approach proved to be a winning formula, it involved investors unwittingly taking on considerable risk.

Sector bias

Forster points out emerging market economies are often heavily biased towards particular sectors and companies.

“Russia, for example, is largely an oil play and it can represent a big chunk of the portfolio, as it is an easy way to get oil and energy exposure,” he explained.

“It is important to remember large institutional investors often use these large cap stocks [in the BRIC economies] to make momentum plays, so you are getting market noise rather than emerging market exposure.”

While the Russian market has a 64 per cent exposure to energy, similar biases exist in other markets. Taiwan has a 54 per cent exposure to technology and Mexico a 40 per cent bias to telecoms.

“This leads to very strong biases,” Forster said.

“It is worth having an emerging market investment, but you need to keep it broad within the subset.”

Aberdeen Asset Management’s Singapore-based fund manager Asia-Pacific (ex-Japan), Andrew Gillan, agrees many investors have viewed BRIC funds as a simple way to access emerging market growth without really appreciating the nature of their investment.

“It has been easy from a marketing perspective to focus on BRIC countries, but our view is that you are limiting yourself too much … We advocate looking further than that,” he said.

Forster agreed investors were often concentrating their allocations unintentionally by taking the BRIC route.

“Why limit yourself to just these opportunities? You need to consider the second-tier companies too for growth.”

BRIC or broke?

The dramatic declines during 2008 in emerging markets have seen many investors begin to question the wisdom of their BRIC allocations.

Gillan believes the idea of using a BRIC fund to gain an emerging market exposure may be on its last legs.

“I would not be surprised to see more diversified funds than just BRIC funds in the future.”

In fact, the very different prospects for the various BRIC economies may prove to be the undoing of this approach to emerging market investing.

“BRIC have all the population, however, there is a very big difference between areas in the group,” Genocchio noted.

“For example, Russia has problems and could muddle the BRIC concept as it is meddling with its markets.”

Gillan agrees the changed situation in Russia may make the BRIC concept less attractive.

“We like Brazil and India as markets, but have very little in Russia and we have had difficulty finding good value companies in China.”

The potential for strong performance in other countries is also seeing the BRIC concept break down.

For example, Aberdeen is keen on Latin American markets and currently has 10 per cent of its fund in Mexico because it has some strongly performing companies in the retail, food and beverage and banking sectors.

“We are overweight Mexico in relation to the benchmark,” Gillan said.

“We also like South-East Asia, Thailand and Indonesia, but they are not picked up in the benchmarks.”

While the Asian economies are seen as offering strong growth prospects, many investment experts are concerned about the overleverage in many Eastern European countries.

“Emerging markets is a tough investment group as there is so much in there,” Genocchio explained.

Many emerging market enthusiasts argue that while BRIC is an easy to understand concept, a better approach for planners and their clients may be to make investments into regional funds or global emerging market funds.

“A global emerging market or Asian equity market fund is a better first option as the manager can change exposures around based on changing circumstances, valuations or country risks,” Gillan said.

He believes investors also need to gain a better understanding of the type of companies into which emerging market funds invest.

“Often people think they are only investing in domestically-focused companies, but many emerging market companies are in fact multinationals.”

Despite the doubts, the BRIC group retains its fans.

The head of global economic research at Goldman Sachs, Jim O’Neill, who is credited with coining the BRIC acronym in 2001, continues to argue the BRIC story is far from over.

In a January article in London’s Financial Times, he pointed out Goldman Sachs was forecasting world gross domestic product (GDP) growth in 2009 of only 0.6 per cent, of which 4.7 per cent was from the BRICs and —1.2 per cent from the advanced economies.

“The BRIC countries will be the only source of domestic demand growth globally in 2009,” he wrote.

In 2010, Goldman Sachs is projecting domestic demand growth in BRIC economies will be 7.2 per cent, largely fuelled by China’s enormous stimulus.

O’Neill pointed out that by the end of the decade, the BRICs will be close to representing 20 per cent of global GDP.

“Rather than suggesting our BRIC dream may be derailed by the global recession, the notion that the BRICs can become collectively bigger than the G7 by 2035 is becoming more plausible,” he wrote.

If growth like this really does materialise, the BRICs may be far from broke.