The four powerhouses of the future

What are brics? The recovery and outperformance of emerging market equity markets has revitalised interest in emerging market investing and specifically in Brics. This acronym for Brazil, Russia, India and China was first identified by Goldman Sachs & Co. in 2001. The initial research (Dreaming With Brics: The Path to 2050) envisaged how the world would change over the next 50 years and identified which countries would become the driving force of the global economy. The research projected that by 2040, the GDPs of Brazil, Russia, India and China could exceed the GDP of the current G6 (US, Japan, Germany, France, UK and Italy), even though today the Brics economies account for less that 15 per cent of G6 GDPs. What is driving brics growth? Unlike much of the developed world, which is facing the prospect of a shrinking workforce due to the impending retirement of the baby-boomer generation, the Brics economies enjoy a substantial demographic advantage. Together, the four Brics countries have a population of 2.7bn out of the world’s 6.5bn (America at 33 per cent of world GDP has a mere 300m). However, large populations are not enough to drive growth alone. Key to long-term economic growth is the age of a nation’s working population and its relative productivity. There are two parts to this story. China and India with their large, increasingly urban populations are industrialising rapidly and driving unprecedented demand for commodities and energy. Key to supplying this demand are Russia and Brazil. Continued access to these resources are actually so critical to China and India, that both China and India have signed oil supply agreements with Russian companies as well as assisting funding infrastructure investment in Brazil. As this trade relationship between the Brics economies deepens, they will become mutually supportive of each other’s growth. In addition to above story of supply and demand, there is also the phenomenon of the emerging middle class. It is therefore not just a growth story based on production but also consumption. Goldman Sachs estimates that the number of people with annual income over $3,000 (E2,430) in the Bric economies, a key threshold for entry into the middle class, could double in the next three years, and reach 800m by 2015. This is also why Brics is fundamentally different to the emerging market and Asian investment themes. Brics growth is secular not cyclical and hence their growth is much less dependent on the G6 growth that emerging market or Asian equity markets rely on. The Brics economies’ success is not based on the US or European consumer but on the Brics consumer. The Brics dream While each of the Bric economies faces its own unique challenges to ensure development is kept on track, if the Brics come even close to research projections, the implications for the pattern of growth and economic activity could be immense. The latest research on the subject (published in February 2006 by GS & Co) shows that each of the four countries has in fact grown more strongly than initially projected. The following conditions for growth, we believe, are key to the Brics realising their potential:

• Sound macro-economic policy and a stable macro-economic background;
• Strong, stable political institutions;
• Openness of markets;
• High levels of education.

In looking at the volatility of the MSCI World index, current levels indicate the lowest level of return dispersion among stocks for 20 years, making it difficult for “developed market” equity funds to beat their benchmarks. One needs to look to other markets, such as the Bric economies, for different opportunities and therefore the higher potential for high nominal returns and outperformance. As a group, the Brics are attractively valued relative to developed markets, and a strategic allocation to Brics is likely to improve a portfolio’s risk/return profile.