Poor Returns Cast Cloud over BRIC Equity Funds

The term, coined in 2001 by Goldman Sachs banker Jim O'Neill, provided a catchy acronym to unite the four biggest emerging economies, two of which were also growing at turbo-charged 9-12 percent rates.

Since then economic growth in Brazil, Russia, India and China has surpassed even O'Neill's expectations, their aggregate GDP having quadrupled to create the equivalent of five British economies. It looks likely, as O'Neill reckons, the BRICs will account for almost a third of the world economy by 2020, up from 20 percent now.

Applying the concept to equity investments has proved less rewarding, however.

Viewed over 10 years, MSCI's BRIC index has returned a handsome 450 percent, Thomson Reuters data shows, versus 320 percent on emerging markets and 98 percent on developed markets.

But much of that is due to an explosive start. MSCI's BRIC index returned over 500 percent from 2001 to 2007, significantly outperforming emerging markets. Returns have since slumped, with losses of 8.6 percent in the past five years in dollar terms. The main EM index has returned 5 percent in this period.

That has taken a toll on the BRIC funds that proliferated after 2001 to capture these countries' booming economic growth.

The funds' asset base has almost halved from the 2007 peak to around 12 billion euros, according to data from Lipper, a Thomson Reuters company. And investor interest has reversed -- fund tracker EPFR Global reports outflows of $1.1 billion from BRIC funds in 2012, extending last year's $5.4 billion loss.

Broader emerging funds though are still drawing plenty of interest, absorbing $18 billion this year. And Lipper data shows their asset base has doubled since 2006 to 214 billion euros.

All that is providing fodder to critics who view BRIC funds as an arbitrary grouping of four vastly differing markets.

"We don't think of BRICs as an entity. Our strategy is to see which companies we like and we own those companies," said Jeff Chowdhry, a fund manager at F&C Investments.

"BRIC is an investment fad that's had its day. What you will see is more and more of these funds quietly closing down."

And deteriorating BRIC newsflow has deepened the gloom.

Lack of reform has pushed India's once-roaring growth to three-year lows. China's 10-percent growth spurt is fading, Brazil's economy is stagnating and Russia remains hostage to oil prices.

This year, MSCI BRIC .MIBC00000PUS has gained less than 1 percent while emerging markets .MSCIEF are up 6 percent.

WHAT WENT WRONG

It is worth remembering that while growth, underpinned by demographics and consumption, was BRIC funds' main sales pitch, it was never a guarantee of equity profits.

As an oft-cited study from Credit Suisse/London Business School notes, the link between growth and stock-market performance is "statistically weak and often perverse".

"There were a lot of opportunistic fund launches based on the false premise that you could separate the BRIC markets from others because of their supposed GDP potential and size," said John-Paul Smith, head of emerging equities at Deutsche Bank.

China makes up 40 percent of the MSCI BRIC index. But during two decades of double-digit gross domestic product growth, equity investors have swallowed a 10 percent loss.

The BRICs' liquid markets and big, well-known companies may also have been their undoing. In 2002 the BRICs offered a significant measure of diversification for investors keen to venture into emerging markets but wary of smaller markets.

That diversification advantage has almost vanished, with the BRIC index moving in lock-step to developed markets: correlation is now at 0.9 compared with just 0.4 a decade ago.

And these big companies, from Russia's Gazprom to Brazil's Petrobras, are often state-run or subject to state meddling. And that has taken a heavy toll on their shares.

PRICED FOR WORST CASE

So does BRIC have a future as a strategy?

The concept still has plenty of fans. Bill Maldonado, head of equities at HSBC Global Asset Management, says BRIC offers a liquid and convenient proxy for EM. He likens it to FTSE-100, an index of the top companies from London's FTSE All-Share index.

Like other BRIC bulls, he reckons current record cheap share valuations - prices relative to expected future earnings - will be the catalyst for BRICs recovery. Many see them priced for a growth and profits collapse, rather than just slowdown.

The BRIC index is trading at 8.2 times forward earnings or a 15 percent discount to broader emerging markets, themselves trading at a large discount to developed peers. In Brazil and Russia, shares are 30-50 percent below their historical average.

"Investors have had macro concerns about those economies, not concerns about individual companies," Maldonado says.

"If we have a stock or a market that's both cheaper and more profitable than the universe, that's where we want to invest."

Goldman Sachs too advises clients to overweight BRIC shares, using a BRIC fund in a diversified portfolio. They predict the Big Four, especially China, are moving towards better-quality, stable growth and that will eventually yield equity returns.

However, Kathryn Koch, senior portfolio strategist at Goldman Sachs Asset Management, also recommends combining a BRIC fund with a fund for Next-11 countries. That's Goldman-speak for a second-tier group of fast-growth economies such as Mexico or Turkey.