Should Brics form a core allocation in portfolios?

Our economists suggest that over the next few years, the Bric countries will grow faster than other emerging markets and at a significantly higher rate than the developed economies. Over the last decade, the MSCI Bric Index returned 276 per cent (cumulative), outperforming the MSCI Emerging Markets Index by 162 per cent and contrasting sharply with the 2 per cent (cumulative) return in the MSCI World Index^*. We believe this pattern of Bric equity outperformance could repeat itself over the next decade as the superior growth trajectory of the Bric markets should continue to translate into superior equity returns over the long run. In the near-term, markets continue to be volatile, and many investors are questioning whether now is an appropriate time to be increasing their equities exposure to Brics. While in the near-term some investors may look to access the strong growth prospects in Brics markets through investing in developed market multinationals with high exposure to Brics, pullbacks in Brics equities should be consindered as a good opportunity to increase allocations to Brics. To address this issue, we consider the fundamentals underpinning the Brics growth story. Greater monetary flexibility In the 1980s and 1990s, Bric countries’ balance sheets were over-levered and burdened by large deficits financed by heavy external borrowing. This resulted in several emerging market-based crises, but also served as a lesson for many emerging market central banks. The Bric countries’ more conservative behaviour over this past decade was reflected in the cleanest balance sheets in their histories. This allowed them greater monetary flexibility than most developed markets, better positioning them to weather the most recent downturn. In previous crises, capital outflows from the Bric markets forced local central banks to raise interest rates to maintain financial stability. For the first time in history, however, Bric economies have been able to cut interest rates in response to adverse external shocks. Conversely, they maintain the ability to raise rates in response to any inflationary pressures from rapid growth. Healthy corporate balance sheets A similar story is apparent in the corporate sector. Fundamentals are robust as evidenced by their returns on equity, which are above their historical levels and their developed market peers. This improvement has come with significant deleveraging and debt/equity ratios of Bric companies are now substantially lower than those in developed markets. Bric corporations are also posting strong free cash flow, a particularly valuable attribute while credit markets remain tight. Valuations supported by strong fundamentals The rally in 2009 lifted Bric equities from crisis-induced lows back to long-term average valuations, when measured by price/earnings, price/book and dividend yield. Valuations are comparable to those for developed markets, despite the Brics’ much stronger growth profile. We expect this growth to be fuelled by domestic consumer demand, infrastructure spending and technology-driven improvements in productivity. In summary, we believe we are in the midst of a seismic shift of global growth from developed to developing markets and we believe that investing in Bric countries is key to increasing emerging markets equity exposure. ^*Source: MSCI, 1 Jan 2000 to 31 Dec 2009, gross total return. This article is for information only and should not be construed as investment advice.