How Sturdy Are BRICs?

Funds that focus their investments in Brazil, Russia, India, and China are gaining prominence, but some analysts have their doubts

Jim O'Neill laughs about the time he gave a speech to more than a thousand people at a recent conference in Rio de Janeiro. As usual, Goldman Sachs' head of global economic research was presenting his theory that Brazil, Russia, India, and China -- or BRICs, as he calls the group -- will become four of the seven largest economies in the world by 2050. As O'Neill walked up to the podium, the introducer whispered in his ear that the economist must have added Brazil because a "B" made the BRIC acronym sound good. Turns out O'Neill's catchy saying, and the research that backs it up, have found believers on Wall Street, prompting the development of new products.

As of May 24, investors poured $5.5 billion into BRIC funds, according to Emerging Portfolio Fund Research, which began tracking these inflows in October, 2005. BRICs had their first recorded outflows during the week ended May 24, losing $370 million, according to Boston Fund Research's announcement on May 29.

The outflows are likely the result of recent weakness in emerging-market stocks amid uncertainty about the direction of interest rates (See BW Online, 5/23/06, "Emerging Markets Beat Quick Retreat"). The Morgan Stanley Capital International BRIC Equity Index plunged another 3% to 215.477 on Tuesday, after having already given up ground in earlier weeks from 236.383 on May 17. Still, the BRIC index has had a huge run from its 74.684 level at the start of 2002.


  Some industry veterans doubt O'Neill's theory, and shrug off BRICs as a marketing ploy. "BRIC is to an extent a rebranding," says Darren Read, head of emerging-markets strategy at UBS. He says the phrase "emerging markets" became a dirty word after people lost money in the Tequila Crisis of 1994, the Asian crisis of 1997, and the Russian crisis of 1998. "It's reborn as BRIC. It's an image makeover."

O'Neill begs to differ. He insists that BRICs don't belong in the volatile asset class. "We think of BRICs as being four distinct countries that are part of the modern, globalized world," he says. "We think they're very different than emerging markets."

O'Neill first coined the term BRIC in November, 2001, in a report titled "Building Better Global Economic BRICs" that examined what might happen to Brazil, Russia, India, and China over the next 10 years. In it, he says: "In 2001 and 2002, real GDP growth in large emerging market economies will exceed that of the G7." In the end, he declares, "world policymaking forums should be re-organized and in particular, the G7 should be adjusted to incorporate BRIC representatives."


  O'Neill, who started at Goldman as a foreign currency analyst in 1995, says his idea coincided with September 11. He wanted his report to address problems with globalization and show that developing countries must also stand to benefit from it.

Back then, Wall Street didn't pay attention. They watched Argentina's government debt repayment problems, which caused a swoon in emerging-markets equities and triggered the country's economic collapse in 2002. Emerging markets had such a bad name at the time that few predicted the spectacular run-up that took place in Latin American stocks only a couple years later.

The BRICs concept started picking up buzz in 2003, experts say, when Goldman Sachs published the 24-page "Dreaming with BRICs: The Path to 2050." Under O'Neill's supervision, economists Dominic Wilson and Roopa Purushothaman laid out more methodical arguments to explain that Brazil, Russia, India, and China might become major economies in 45 years (not 10). Their first premise was that BRICs "could become a much larger force in the world economy." They concluded: "The list of the world's 10 largest economies may look quite different in 2050. The largest economies in the world (by GDP) may no longer be the richest (by income per capita)."


  That prediction put BRICs in the limelight. Fund companies, including HSBC Investments, Allianz Global Investors, Schroders Investment Management, and Franklin Templeton Investments, have started selling BRIC funds in recent years. Goldman Sachs Asset Management recently launched its Luxembourg-registered BRIC fund in European countries such as Britain, Spain, and Italy. The BRIC fund consists of 25 to 35 stocks mainly from Brazil, Russia, India, and China. In contrast, Goldman's emerging markets equity fund invests in 60 stocks from various countries all over the world.

Goldman Sachs Asset Management has also registered a U.S. BRIC fund with the Securities & Exchange Commission that's expected to launch June 30. Goldman declined to comment on its BRIC fund for U.S. customers, citing quiet-period rules.

It's too early to tell if BRICs will be a winning investment, especially in tougher times. One of the important developments about BRICs, O'Neill says, is that collectively they have a current-account surplus. They're not dependent on the good will of foreign investors. One sign of faith: The Group of Seven has invited BRIC finance ministers to join them at virtually every meeting held since the end of 2004, he says.


  One naysayer is Rich Nuzum, Americas business leader for Mercer Investment Consulting. He points out that BRICs are an easy sell because newspapers have been spinning positive stories about those countries as growth markets. "Talking about the other 60 markets doesn't have the same cachet," Nuzum says.

But he doesn't recommend limiting yourself to the countries that everyone already knows. Instead, Nuzum believes investors should give emerging markets portfolio managers the freedom to invest where they see value. He says more international exposure is wise, but "investing in BRIC funds specifically doesn't make sense." It looks like the BRIC debate will keep building.

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