BRIC Dominance Fades as State Meddling Curbs Equity Returns
Stocks in the biggest developing markets are lagging behind global equities for a record third year as faster economic growth proves no lure for investors amid concerns over government interference in markets.
The MSCI BRIC Index (MXBRIC) of shares in Brazil, Russia, India and China rose 11 percent this year through Dec. 28, trailing the MSCI All-Country World Index by 1.6 percentage points. The trend will probably persist in 2013, according to John-Paul Smith, a Deutsche Bank AG strategist. Mutual funds that invest in BRIC nations have posted $1.65 billion of outflows as Brazilian politicians intervened to cut utility rates, China maintained control of its biggest companies and Russian businesses spent shareholder money on projects favored by the government.
“This whole revolution of going from a socialistic mentality to a market economy mentality is not complete,” Mark Mobius, who oversees about $40 billion as the executive chairman of Templeton Emerging Markets Group and has invested in developing countries for more than 25 years, said in a Dec. 12 phone interview from Nairobi. “We’re still in the middle of that and have a long way to go.”
Stocks of BRIC companies beat global equities by 403 percentage points in the eight years after Goldman Sachs Group Inc. coined the term in 2001, as their economies grew more than threefold. Gross domestic product is now expanding at the slowest rate compared to the rest of the world since 1998. The International Monetary Fund sees average growth in the four countries of 4.5 percent this year, down from 8.1 percent in 2010, compared with 3.3 percent for the world economy.
The BRIC index rose less than 0.1 percent in New York today, while the All-Country measure jumped 0.8 percent.
While the BRIC gauge increased this year, the value of shares traded on local bourses fell to a three-year low and the measure is still 36 percent below its October 2007 peak. The outlier is India, where the benchmark BSE India Sensitive Index (SENSEX) surged 26 percent as the government responded to the threat of a credit-rating downgrade with its biggest push in a decade to open up the economy to foreign investment.
“Governments typically only carry out reforms when they have their back to the wall,” Ruchir Sharma, the New York-based head of emerging-market equities and global macro at Morgan Stanley Investment Management, which oversees about $330 billion, said in a Nov. 29 phone interview. “It’s moving in the right direction in some of these countries, but the task is so enormous that I’m not sure it’s enough.”
The drop in stock trading makes it harder for governments to revive growth.
Brazil may face an “equity gap” of more than $1 trillion this decade as companies’ financing needs outstrip investor demand for shares, according to the McKinsey Global Institute. Russian Prime Minister Dmitry Medvedev has said a growing securities industry will help the nation diversify its economy away from oil. Chinese companies need funding sources outside the banking system, according toJeff Urbina, an emerging market money manager at William Blair & Co. India relies on foreign inflows to fund its current-account deficit.
Many investors in BRIC companies prefer to buy shares on overseas exchanges. Brazil’s state-run Petroleo Brasileiro SA (PETR4) and Russia’s OAO Gazprom are more actively traded abroad than on local bourses, according to data compiled by Bloomberg. The 30- day average value of trades in 10 Russian companies including Gazprom is 62 percent higher in London (OGZD) than the same companies’ Moscow-listed shares, the data show.
“You need good publicly traded markets if you’re really going to develop long term,” Urbina, the Chicago-based money manager whose $958 million William Blair Emerging Markets Growth Fund (BIEMX) has outperformed 90 percent of peers tracked by Bloomberg during the past three years, said in a Dec. 3 phone interview.
India has taken steps that make it the most promising of the four countries in terms of long-term stock gains, said Jim O’Neill, who created the term BRIC for economies his colleagues projected would join the world’s biggest by 2050 and now oversees about $716 billion as the chairman of Goldman Sachs Asset Management in London.
Prime Minister Manmohan Singh’s administration removed barriers this year on foreign investment in the retail and aviation industries, opened the stock market to individual investors abroad and cut fuel subsidies.Palaniappan Chidambaram, India’s finance minister, is also seeking to open up the insurance and pension industries to overseas capital.
“The measures we have announced are important to bring back growth in the economy,” the finance minister told reporters in New Delhi Dec. 12.
International investors bought a net $24 billion of the nation’s shares in 2012, the second-most among 10 Asian markets tracked by Bloomberg after Japan.
India’s government “is taking the issues head on to stimulate growth and get back investor confidence,” said Soren Beck-Petersen, a London-based director at HSBC Global Asset Management, whose $1.3 billion BRIC equity fund has increased its Indian holdings this year.
Foreign investors reduced holdings in Kolkata-based Coal India Ltd. (COAL), 90 percent owned by the government, to 5.5 percent of outstanding shares as of Sept. 30, from 6.3 percent a year earlier. The world’s largest coal producer has agreed to increase wages and curb price increases this year as politicians urge it to protect power utilities from higher raw-material costs. Mobius said he’s been selling Indian mining stocks because of government restrictions on the industry.
In China, where the Shanghai Composite Index (SHCOMP) has climbed 1.5 percent this year, the worst performance among the BRICs, the government cut trading fees and dividend taxes for long-term investors while more than doubling the amount of shares overseas money managers can own to restore confidence as trading volumes sank to a four-year low last month. Trading has since increased by about 14 percent, data compiled by Bloomberg show.
The ruling Communist Party, which began its once-a-decade leadership transition this year, has also widened the yuan’s trading band and emphasized the need to shift the world’s second-biggest economy to a growth model based on consumer consumption rather than government-led investment spending.
“The kind of changes that China is going through are very exciting, are very positive,” said O’Neill, who issued a note this month that was bullish on Chinese equities.
Officials at the CSRC’s media department didn’t respond to two phone calls and a faxed list of questions seeking comment.
Policy makers so far have focused on increasing the pool of buyers for Chinese assets, rather than boosting the role of free markets and privately-run companies in the broader economy, Deutsche Bank’s Smith said in a Dec. 3 phone interview.
The eight largest companies by market value in the Shanghai Composite are state-controlled, data compiled by Bloomberg show. More than 25 percent of China’s government-run enterprises are unprofitable and productivity growth has trailed non-state firms by about 66 percent the past three decades, the World Bank said in a February report. State businesses may become a long-term drag on economic growth, the Washington-based lender said.
Equity investors are shunning government enterprises in favor of smaller, private companies that cater to Chinese consumers. An MSCI gauge of Chinese financial stocks, dominated by state-owned banks that were compelled to lend to local governments during the financial crisis, is valued at 8 times reported earnings, 36 percent below its five-year average. MSCI’s index of consumer staples companies trades for 28 times profits, a 34 premium to its historical mean, data compiled by Bloomberg show.
“You have this contest between the un-investible and the overvalued,” Smith, who prefers holding cash to investing in BRIC shares, said from London.
Russia joined the World Trade Organization and upgraded its financial trading systems this year. Finance Minister Anton Siluanov told reporters in Sochi Dec. 4 that the government is committed to improving access to the market for foreigners. “We are going to continue this work,” he said.
Investors are more concerned about a lack of corporate governance in Russia than how they access local markets, said William Blair’s Urbina.
The Micex index, which rose 5.4 percent in 2012, is valued at 5.9 times profits, the lowest level among gauges for 45 emerging and developed markets, data compiled by Bloomberg show.
Shares of Moscow-based Gazprom dropped 16 percent this year even as analysts estimated the company will earn about $38 billion in 2012, making it the world’s most profitable energy producer. The state-run gas-export monopoly is using its cash to finance the industry’s largest capital expenditure program, part of which goes to fund projects favored by President Vladimir Putin.
“You can create all the value you want at these companies, but if there’s no corporate governance, it’s not going to get to the shareholders -- and that is a real big issue in these markets, particularly in Russia,” Urbina said.
Investors also are punishing stocks in Brazil, where PresidentDilma Rousseff and her ruling Workers’ Party have focused on improving infrastructure, boosting consumers’ spending power and reducing costs for domestic manufacturers as economic growth weakened to 0.6 percent in the third quarter from the previous three months.
Rousseff announced plans this year to cut utility rates by as much as 28 percent, called on banks to reduce borrowing costs to levels that would leave them with “civil” profits and approved new phone industry rules designed to increase competition. Economists surveyed by Brazil’s central bank on Dec. 21 predicted GDP will increase 3.3 percent next year.
For stock investors, the measures are reducing earnings prospects for industries with a combined weighting of about 70 percent in the benchmark Bovespa index. Intervention in the currency market sent the Brazilian real down more than 8 percent this year against the dollar, the second-worst performer among 16 major currencies after the yen.
“Foreign investors are paying a price for having had too rosy a perception of what the Labor party and the federal government was about,” saidPaulo Bilyk, the chief investment officer at Rio Bravo in Sao Paulo, which oversees about $3.5 billion in Brazilian equity and fixed-income investments.
Stock trading by local individuals this year through November shrunk to the smallest proportion of total transactions since 1999, data from the Sao Paulo-based Bovespa exchange show.
“It’s not true that we are interventionists, but we have done reforms,”Guido Mantega, Brazil’s finance minister, said in a Dec. 4 interview in the capital, Brasilia. “Some of them hurt and would go against very minority interests.”
If stock valuations are a guide, investors have low expectations that policy makers in the BRIC countries will loosen control over their economies. The MSCI BRIC index is valued at 10 times reported earnings, a 13 percent discount versus its three-year average and about 30 percent less than the multiple on MSCI’s All-Country gauge, data compiled by Bloomberg show.
Should governments actually deliver, the markets that Goldman predicted were on pace to join the U.S. and Japan as the top economies will reward investors, saidAllan Conway, who manages Schroder Investment Management’s $2.5 billion BRIC equity fund from London.
“The fact that we talk about how much further there is to go -- that shows the opportunity,” Conway said in a Dec. 4 phone interview. “If it was all done and dusted and in the price, from an investment perspective it wouldn’t be interesting anymore.”
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