Building the future with BRICs

THE stock markets of the world have taken the plunge, and along with them have taken away fortunes of several shareholders. The subprime mortgage meltdown made 2007 and the beginning of 2008 disastrous years for Bear Stearns, one of the largest underwriters of mortgage bonds. With the recession hitting the US markets, and the collapse of Bear Stearns (even after JP Morgan’s revised bid), there is widespread bearish sentiment which is expected to last for a good remainder of the year. Closer to home, the dollar peg for Middle Eastern currencies has long served the countries well, contributing to macroeconomic stability and facilitating AGCC convergence toward monetary union. However, the recent significant depreciation of the dollar could potentially pose inflationary and exchange rate pressures on the region.

Frantic investors are thus looking elsewhere to make value long term investments. The burning question of where to make these investments to yield sound returns plagues many an average investor with limited capital. The BRIC economies have emerged as a viable alternative for almost assured positive returns.

What are BRIC economies?

The BRIC economies today, i.e. the economies of Brazil, Russia, India and China are slowly becoming a force to reckon with. Over the next 50 years, Brazil, Russia, India and China — the BRIC economies — could become a much larger power in the world economy. If things go right, by financial projections at Goldman Sachs, in less than 40 years, the BRIC economies together could be larger than the G6 in US dollar terms. By 2025 they could account for over half the size of the G6. Currently they are worth less than 15 per cent. Of the current G6, only the US and Japan may be among the six largest economies in US dollar terms in 2050. (The G6 comprises the US, UK, Japan, France, Germany and Italy).

Why the BRIC economies?

The BRIC economies are classified as what we would essentially classify as “emerging markets”. These emerging markets have the potential to grow substantially as we enter the next decade. They are poised to be among the most interesting global economic stories and investment themes for many years to come. However, these BRICs can be seen as much more than a new emerging market theme. The BRICs are a key aspect of the modern globalised era. As of March 2008, the top five countries in the MSCI Emerging Markets index were: Brazil, China, Korea, Taiwan and Russia, accounting for more than 60 per cent of total weight in the benchmark.

There are two advantages to the emerging asset class: they grow more over the long term. The MSCI has gained more than 600 per cent since 1988, beating the S&P 500 by 200 percentage points. What distinguishes the BRICs from any other story of EM growth is their ability to influence, and be influenced by, the global economy and global markets in a broad fashion. Thus, most importantly the fluctuations of these emerging markets may not be strongly correlated with developed markets. So the recession towards which the American economy seems to be headed really would not adversely affect these markets very much, especially in the long run.

A closer look at statistics

BRICs stock markets have generally performed very strongly in the last five years, since 2003, with Brazilian, Russian and Indian indices all up by around 150 per cent over that period. China is the one exception, where the idiosyncrasies of the local market have seen lacklustre performances. China provides a warning that the local market may not be the best investment vehicle for the local growth story. BRIC market capitalisation, however, continues to climb. It was close to a remarkable four per cent of the global total in 2005 and grew much more ever since.

It is also not astonishing that the BRIC’s now hold more than 30 per cent of world reserves. China is the dominant contributor, but Russia, India and Brazil have all accumulated substantial reserves also. There have been numerous signs of developing trade relationships, including the sharp increase in Brazilian trade with China and Chinese investment commitments in Brazil. India (in intellectual property) and Brazil (in agriculture) have also illustrated their policymaking leadership among developing countries through the WTO negotiation process.

Despite this reserve accumulation, real exchange rates in each country have appreciated over the last two years.

Trade among the BRIC have also accelerated, with intra-BRIC trade now nearly eight per cent of their total trade compared with 5 per cent in 2000.

Between 2000 and 2005, the BRICs contributed roughly 28 per cent of global growth in US dollar terms, and 55 per cent in purchasing power parity (PPP) terms.

Their share of global trade continues to climb at a rapid rate. At close to 15-16 per cent currently, it is now double its level in 2001.

Mergers, acquisitions

There’s been a lot of other great news. As BRIC companies expand their own global presence, the number of mergers and acquisitions (M&A) have also picked up. By September 2001, there was an extensive merger and acquisition overdrive with the total M&A volume from BRIC nations surging past the $100-billion mark in the ending quarter of 2007. Despite the 47 per cent in the global M&A market in third quarter of 2007 from the previous quarter, M&A volume from BRIC countries rose 5 per cent to $100.1 billion from $95.5 billion in the second quarter, according to global financial data provider Dealogic.

Besides, the number of large value deals also increased in the quarter, contrary to the general perception that the US subprime crisis would adversely impact the deal volumes. This again proves the fact that the markets of the BRIC economies are not adversely affected by the developed markets, just as previously mentioned. Also by Dealogic estimates, sixteen deals over $1 billion were announced in Q3 2007 for BRIC countries compared to 12 such deals in Q2 2007 and 12 deals in Q1 2007.

These M&A deals show that utility and energy have been the most targeted industry by BRICs in 2007 with $48.3 billion through 191 deals, followed by oil and gas industry with $45.2 billion (120 deals).

The net worth of individuals who are mostly owners of large conglomerates in the BRIC economies has increased heavily. This year, China took the second spot in Asia with 42 billionaires compared with 24 from Japan, which remained at the same level as last year. China added 22 new billionaires to its list of 20 last year to overtake Japan as the Asian nation with second-most number of billionaires. Among the BRIC countries, the number of billionaires from Brazil dropped from 20 to 18 this year. Russia, China and India added 34, 22 and 17 new billionaires to their tally, respectively.

Together, the three emerging economies out of the BRIC pack constituted 40 per cent of the increase in the number of billionaires which totalled 179 over last year. Almost one-third of the total increase in net worth of global billionaires has come from India and Russia put together.

Fund activity

Since capital markets in BRIC countries are less efficient than those in developed ones, talented fund managers should be able to outperform passively managed BRIC index funds. Before investing in a BRIC fund, check any diversified emerging-markets fund you own to see how much it holds in these exciting, but potentially dangerous, markets. Such a fund may provide sufficient exposure to BRIC stocks.

Are there more BRICs?

An interesting report by Goldman Sachs reveals that there is a larger developing-country set termed the Next Eleven (N-11), though whether they will emerge is still an open question for many. In thinking about other countries that might have BRICs like potential, they focused on demographic profiles, which drove much of their analysis.

Their analysis showed that the group shows broad representation by region and includes Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, Philippines, Turkey and Vietnam. These countries have exhibited enormous activity in the last decade and are projected to do for the years to come assuming that their governmental institutions remain regulated.

Conclusion

Investors should consider taking long-term exposures in the markets of these BRIC economies which are expected to outperform the economies of the G6, or rather the G7 (including Canada) by leaps and bounds in the next forty years to come. Although, of course, market activity cannot be speculated for such a long time period especially taking into account that policy-settings in these countries are often a problem, they still remain a hot market to invest long term. Studying these emerging markets meticulously initially to determine growth, potential returns and market risk is the obvious first step to be undertaken. Start doing your homework. After all, there is a future to be built with these ‘BRICs’.

Source:  By Siddharth Arora
Friday, March 28, 2008 8:57:50 PM Oman Times