Most investors understand the acronym BRIC to be one of the greatest economies in the world: Brazil, Russia, India, and China. These countries contribute 22.25% to the World GDP.

IMF forecasts that by 2021 India’s GDP growth will be 8.1% and China’s GDP growth will be 5.8%, which is above the 5.1% of the emerging markets’ growth rate and the 1.7% developed markets’ growth rate.

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The mentioned characteristics make the investments in BRIC countries very attractive. Foreign Direct Investments net inflows represent 17.79% of the world’s foreign direct investments net inflows.

What is the performance of the specified countries?

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For the last five years, MSCI China Index (Ticker:MXCN) and MSCI India Index (Ticker:MXIN) significantly outperformed MSCI Emerging Markets Index (Ticker:MXEF). However, MSCI Russia Index (Ticker:MXRU) and MSCI Brazil Index (Ticker:MCBR) significantly underperformed.

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What happens if the mentioned countries were combined in the single portfolio?

Based on Harry Markowitz “Modern portfolio theory,” the overall risk of the portfolio decreases when the correlation of the different stocks/indexes is less than perfectly positively correlated.

I have constructed a correlation matrix based on the five last years. MSCI Russia Index and MSCI Brazil Index have a higher positive correlation, which confirms their performance. MSCI China Index and MSCI India Index tend to have a lower positive correlation.

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Currencies are even less correlated that increases diversification effect and decreases overall portfolio risk.

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I will try to see if adding all the mentioned countries to a single portfolio provides investors with benefits.

I will compare the performance of the iShares MSCi BRIC ETF (NYSEARCA:BKF)and Guggenheim BRIC ETF (NYSEARCA:EEB) with FTSE Emerging Markets ETF(NYSEARCA:VWO), the largest well-diversified equity ETF as an investment opportunity for the American investor.

For the last year, both funds were volatile and had periods when trading volume was significantly higher. Both of the funds experienced a massive sell-off in the beginning of the January that affected all the emerging markets funds.

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For the last six months, both funds were traded above the 50- and 200-day average. November month is associated with a president election in the USA that increased uncertainty on the markets.

For the last year, Guggenheim BRIC ETF outperformed FTSE Emerging Markets ETF by 7.01% and iShares MSCI BRIC ETF underperformed FTSE Emerging Markets ETF by 0.12%.

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Why there is a difference in performance? Is it related to the asset, security or currency selection?

 To answer the mentioned question, I will compare each BRIC ETF.

Comparing both ETFs, the performance difference is due to the country allocation and security selection.

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  • While earnings yield for the iShares MSCI BRIC ETF is higher by 3.14%, the dividend yield is higher only by 0.27%. Despite the lower payment to the investors from every dollar earned, companies have more reinvestment opportunities, which may lead to higher growth in the future.
  • Guggenheim BRIC ETF is overvalued based on the P/E and P/FCF ratios. Still, Guggenheim BRIC ETF is undervalued based on the P/S ratio.
  • ROE is 3.84% higher for iShares MSCI BRIC ETF because of the higher profit margin and asset turnover based on DuPont analysis. Guggenheim BRIC ETFcompanies earn less per dollar of sales and assets.

The allocation can explain the difference in performance.

  • Overweight in China and India and underweight in Brazil and Russia resulted in the underperformance of the iShares MSCI BRIC ETF.

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Security selection can provide more insight into the difference.

  • Underweight in Financials, Industrials, Healthcare, and Real Estate and overweight in Energy, Information Technology, Telecommunication Services, and Materials led to the better performance of the Guggenheim BRIC ETF.

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To continue my analysis, I will do a small overview of the countries and their economic conditions, which will explain past performances and make future projections.

  • Russia

For the last year, iShares MSCI BRIC ETF and Guggenheim BRIC ETFunderperformed MSCI Russia Index.

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Is it better to invest only in the Russian market?

Will the Russian market outperform in the future?

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  • The Russian economy is highly dependable on the exports oil and natural gas. As of 2015 exportations of oil and gas consisted of 63% of the GDP.
  • With a sharp decline in the price of oil and natural gas and the sanctions imposed over the annexation of Crimea, the Russian economy has entered a recession.

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  • Russia has a competitive advantage in the price of the extraction of the oil, which is one of the cheapest in the world at $19.21. Taking into account the low cost of extraction, an increase in the price of oil will not be a significant factor for overall economic recovery. Russia is not expected to recover until late 2017.

Why is equity outperforming if the economy is not doing well?

  • Since the recession, inflation has increased to 15.6% from 7.8% and the ruble has depreciated to 72.52 from 58.25.
  • A strict monetary policy of cutting interest rates to 10% from 17% has decreased inflation to 7.1% and appreciated the ruble to 64.50.
  • Monetary policy had a high cost: total reserves declined from $509.62 bn in 2013 to 368.03 in 2015 bn.
  • The drop in inflation and ruble appreciation has led to the outstanding performance of Russian equity.

Will the performance continue in the future?

  • Based on the projections, the ruble is expected to appreciate by 4.86% and inflation decrease by 2.2%, which will translate into good performance.
  • Nevertheless, in terms of the economic forecasts, political risk is significant, and a new set of sanctions may turn into another deep recession. With decreasing reserves, the government will be limited in support of the economy.
  • Foreign direct investment net inflow fell from 69.2bn in 2013 to 6.47bn in 2015 due to the political risk. The election of Donald Trump might be a positive sign for the Russian markets with the expectation of the Russian-American relationship to improve.
  • Still, Donald Trump’s view on international relations is full of uncertainty.

Currency risk

Since the beginning of the year, the ruble was pretty stable and is not expected to depreciate significantly for the next few years.

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  • Brazil

For the last year, iShares MSCI BRIC ETF and Guggenheim BRIC ETFunderperformed MSCI Brazil Index.

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Is it better to invest only in the Brazilian market?

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Will the Brazilian market outperform in the future?

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  • Brazil’s economy has a high dependency on the price of commodities, which contributes 13% to the GDP of Brazil. The prices of commodities decreased dramatically in 2014 based on IMF World Commodity Price Index.
  • Exports in the balance of payments decreased from 315.43 bn in 2013 to 235.8 bn in 2015.

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  • Besides the economic slowdown, Brazil has experienced a political scandal; the impeachment of the president and the corruption scandal of Petrobras(NYSE:PBR) has led to the decrease in foreign direct investment inflow from $96.08 bn to $75.07 bn in 2015.
  • Since 2014, Brazil has entered one of the worst recessions; GDP has decreased from 0.1% to -3.8%.

Why is equity outperforming if the economy is not doing well?

  • Equity performance was boosted after Dilma Rousseff was impeached. A new government has to implement pension reforms and reduce the budget deficit to restore the confidence of the investors and support the recovery. The economy is not expected to recover until late 2017-early 2018.
  • Also, a currency appreciation by 24% has boosted the performance of the Brazilian equity.

Currency risk

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Since the beginning of the year, the real was pretty stable for the year and is not expected to depreciate significantly.

  • Brazil

For the last year, iShares MSCI BRIC ETF and Guggenheim BRIC ETFoutperformed MSCI China Index.

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  • For the past few years, the Chinese economy was one of the fastest growing economies that attracted foreign direct investment. Since 2009, foreign direct investments net inflows increased from 131.057 to 290.28 in 2013.
  • The economy started to slow down in 2013 when the GDP growth decreased from 7.3% to 6.9%. GDP growth is forecasted to decline to 6% in 2018.
  • Many analysts have challenged the government economic data. Skepticism about the accuracy of the data has increased concerns about the even higher slowdown of the Chinese economy.
  • From 2013 to 2015, FDI net inflows decreased from 290 bn to 249 bn.
  • Weak economic data has resulted in the global selloff of Chinese debt earlier this year.
  • The Chinese economy is export-oriented, and exports contribute 22.374% to the GDP. As of 2015, the USA is the largest trading partner of China.
  • The election of Donald Trump has further raised concerns about Chinese GDP growth due to the promised tariffs that will adversely affect the current account and GDP growth.

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  • The other issue is China’s growing debt, which is 246% of the GDP; this has been caused by shadow banking and the housing bubble.

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Currency risk

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  • Since the beginning of the year, CNY has significantly depreciated.
  • Taking into account the high debt-to-GDP ratio, a further depreciation of the CNY will decrease the value of the shareholders.
  • China is expected to be one of the biggest concerns in the emerging markets, which may increase panic among investors and further selloffs.
  • India

For the last year, iShares MSCI BRIC ETF and Guggenheim BRIC ETFoutperformed MSCI India Index.

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  • India is projected by IMF to be one of the fastest growing economies in the world for the next biennium.
  • India has a low, stable inflation because of the monetary policy of Raghuram Rajan, former governor of Reserve Bank of India.
  • The low inflation provides room for interest rate cuts, which are beneficial for foreign investors.
  • For the past three years, foreign direct investments have increased from $23.996 bn to $44.208 bn.
  • On 10/04/2016, RBI decreased interest rates by 1.25% to 6.75%. Lower interest rates support the stability of the national currency.
  • For the next two years, India is forecasted to have current account deficit, which will not depreciate the Indian rupee due to high foreign direct investments.
  • As in many emerging markets countries, India suffers from the high level of corruption and shadow economy.

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  • Increased shadow economy decreases the money supply, which can lead to the currency depreciation. The government is fighting shadow economy by issuing new bills and withdrawing the old one.

Currency risk

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For the last year, the Indian Rupee has become volatile because of Raghuram Rajan’s resignation, concerns about RBI independence and uncertainty about monetary policy.

The bottom line

  • BRIC countries are one of the largest economies in the world, representing 17.79% of the world’s foreign direct investments inflows.
  • BRIC countries are the most important emerging markets countries in the world. For the last five years, while India and China outperformed other emerging markets, Brazil and Russia underperformed.
  • Russian equity markets performed well this year because of the decrease in inflation and appreciation of the currency. The economy is still in recession and is not expected to recover before late 2017. Investments in Russia represent a significant political risk, increased by the uncertainty over Donald Trump’s future international affairs policy.
  • Since the beginning of the year, Brazilian equity had an outstanding performance due to the impeachment of the president and high expectations from the new government. Nevertheless, Brazil is in recession that is not expected to end until early 2018.
  • The Chinese economy was one of the main concerns during the past year that has led to significant selloffs. With the election of the Donald Trump and his plans to impose tariffs on free trade with China, the economic conditions are expected to worsen. The Chinese economy has a high risk of recession due to the possible tariffs and significant debt. Depreciation of the currency is expected which will lead to a loss for shareholders.
  • Indian economy is expected to be the fastest-growing emerging markets with low inflation, stable growth, and monetary policy. Still, risk comes from the corruption and increasing shadow economy.
  • For the last year, iShares MSCI BRIC ETF and Guggenheim BRIC ETF had a difference in performance due to the asset allocation and security selection.
  • The combination of securities with lower correlation than 1 (perfectly correlated) provides diversification benefits through a decrease in the overall risk.
  • Compared to investments in a single country, investments in BRIC ETFs provides diversification benefits.

 

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