BRIC era may be over, says CB Fonder

Swedish manager CB Fonder says in its latest analysis of the BRIC markets that their era may be over following continued underperformance in recent years.

The argument that BRICs (Brazil, Russia, India and China) may not do as well as expected comes despite data showing that investors have benefited significantly from allocating to these markets over the past decade.

CB cites the MSCI BRIC index, which returned over 408% in the past 10 years, compared with the MSCI Europe, which returned ‘just’ 114.8% in euro terms.

“However, there are several reasons to be wary of excessive exposure to the BRICs,” CB said.

The first reason is returns. Over the past three years the MSCI BRIC has underperformed the Europe index. This has happened despite problems in southern Europe – particularly in Portugal, Italy, Ireland, Greece and Spain.

“That emerging markets fall more than developed markets in a falling market may not surprise many; they are considered as high-risk markets where investors are expected to endure large drawdowns while being compensated in a rising market.”

“However, we have not seen a negative overall trend the past three years; MSCI Europe has gained 21.3% while MSCI BRIC has fallen 2.0%, in EUR. The theory that investors in the BRIC countries should be compensated in a rising market has in other words not been working during the last few years.

“At the same time, the standard deviation for MSCI BRIC has been significantly higher, with 16.4% compared to 12.6% for MSCI Europe. And when markets fall, the BRICs are hit harder. The largest drawdown seen in this period was 26.1% compared to 19.1% for MSCI Europe.”

The second main argument against BRICs is that while their economic growth has been strong, this has not been reflected in appreciation in invested capital.

“In the past 40 years, China has had an average profit growth of 41% per year, while growth in earnings per share has been a more modest 10% per year. The corresponding figures for Denmark are 15% and 12%, respectively. As earnings per share is what influence the price per share, and ultimately the return you get as an investor, the difference is important. The average investor in the Chinese stock market has thus seen the total market capitalization rise faster in value than their own investments. One reason for the difference is dilution by right issues that enable businesses to expand and increase their profits. Other factors that have an influence on this dissimilarity are repurchases, IPOs, dividends and buybacks.”

Thirdly, CB Fonder points to higher GDP growth in the BRICs already being discounted. This matters for investors because of the relationship found between GDP growth and stock market returns.

In short, CB said the research it has done suggests that it takes 1% GDP growth in developed European countries to result in positive stock market performance, but in the BRICs it takes 10% GDP growth.

“In summary, the excess return of the BRIC countries compared to the developed countries of Europe has ceased in recent years, despite the fact that we have had long periods of positive overall returns. Furthermore, higher growth rates are not a guarantee for higher long-term returns. We would like to highlight the qualities of developed markets, and the possibility to benefit from growth of emerging markets through investments in developed markets, while keeping the risk in terms of both standard deviation and “skeletons in the closet” at a minimum. As the Swedish saying goes: Do not cross the river for water…”


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