Since the acronym was invented for the emerging markets of Brazil, Russia, India and China, investors hopped on what was for some time a very profitable, if frankly somewhat self-fulfilling, bandwagon.
We believe certain themes can be identified, even if it is as simple as understanding where a bunch of investing sheep will flock to in certain “momentum” driven environments, but such an approach is always in danger of being too simplistic.
While “globalization” generally has increased the degree of interconnectedness in the world, the willingness and ability of investors to discriminate between winners and losers within any particular category, like asset class, region or sector, is better than ever. Even within the same continent, we have Argentina and Venezuela sharing borders with Chile and Colombia — but the contrasts in performance could not be starker. Twenty years ago the market fortunes of Brazil and Argentina were much more closely entwined.
Similarly, whether we are discussing emerging or frontier markets, there are always going to be individual country winners and losers at different stages of their political and economic cycles. This is one reason we believe in a non-indexed investment style that takes advantage of these cycles and volatility, whether at a country or sector level. There is a utility to broadly defining an investment universe by the economic and market development of its constituents, but that is about all it is useful for. The frontier market universe is extremely broad and diverse by any relevant measure; fund managers must add value by making certain judgments about the opportunity set that a country can offer based on the quality of its economic management, political stability and attitude toward private and foreign capital — and certainly not forgetting the valuation point within the investment cycle. Once these judgments are made, then assessments can be made from the bottom up as to the best investment opportunities for expressing that favorable country or global sector view.
Getting back to the BRICs, it seems clear that cracks have started to appear in this particular group of countries. While there might be any number of different reasons for their apparent relative decline, we have identified one that we believe is fundamental and, more importantly, enduring: the belief in state-driven capitalism. Although this is substantially a Chinese model, it has been taken up by the Russians with great vigor since Vladimir Putin first came to power. Now it also seems to be the preferred flavor of Brazil President Dilma Rousseff, in her use of directed subsidized credit through the national development bank and various “state champions” such as Petrobras, along with protectionism through trade barriers and import substitution policies that make investment expensive, slow, inefficient and generally suboptimal. This is clearly demonstrated in the oil and gas sector and the local content rules that have been imposed on Petrobras as it develops the massive Campos offshore oil fields. Meanwhile, structural reform has ended in India, evidenced by the flip-flop on reforms in the retail sector that would have opened it up to foreign competition. The federal government’s relative weakness vs. the state governments that are predominantly run by coalition partners resulted in this much needed reform being reversed. The treatment of foreign capital is also hostile and the recent behavior toward Vodafone over its alleged tax charge does not exactly endear the country to foreign investors. India’s economy suffers from institutionalized government corruption and burdensome regulation capriciously implemented. This all prevents the economy from working efficiently and growing to its potential — hence the country is now facing stagflation and substantial twin deficits.
From our point of view, these trends will not benefit minority investors, economic growth and development, let alone valuation performance. Russia has for a while been penalized for its hostile treatment of foreign investors or indeed any investors that fall foul of Mr. Putin’s priorities for absolute control of the political infrastructure. The use of Gazprom as an organ of state policy along with a number of other major state dominated companies means that minority investors must understand that protection of their rights and long-term profit growth as a prime objective for the company is not what they should expect. Such companies are a very large part of Russian stock market capitalization and also represents almost 40% of stock market capitalization in Brazil.
Many frontier market countries have their own issues. Argentina, for example, is as hostile to foreign private capital as any country in the world, as demonstrated most recently by the nationalization of YPF. However, there are a number of countries that provide thematic as well as specific opportunities; these frontier countries represent a large proportion of the world’s gross domestic product (estimated around 20%) growing at a higher rate with large, young urbanizing populations. Bangladesh, Pakistan and Vietnam boast a combined population of more than 410 million with that demographic profile. We believe this represents a rich opportunity set and that any global investor should want to get exposure to this share of the world’s economy. It is simply a matter of how and when you do it. Relative valuations and growth outlooks make now a propitious moment to build an exposure.
The BRIC countries are still relevant, but are yesterday’s hot story.
Jonathan Binder is chief investment officer of Consilium Investment Management, Fort Lauderdale, Fla.