BRICS expansion lands with a thud, say investment managers

A proposal to expand the BRICS countries to welcome six new emerging markets into the fold isn't receiving the kind of interest from money managers that matches the fanfare.

The BRICS bloc — made up of Brazil, Russia, India, China and South Africa — last month announced that six further countries had been invited to join the club. Effective next year, Argentina, Egypt, Ethiopia, Iran, Saudi Arabia and the United Arab Emirates will officially become BRICS countries, the original members announced at the 15th BRICS summit, held in August in Johannesburg, South Africa.

As they currently stand, the BRICS represent about 26% of global GDP, according to figures from Worldometers.info. The additional six countries bring that representation up to about 29%.

But money managers don't see the expansion as an expression of representation of world GDP, nor as an investment opportunity; rather, it's a geopolitical play, sources said, and is a non-event when it comes to investment.

"I think the motivation is purely geopolitical, to create a balance of power between western Europe and these emerging countries," said Thierry Larose, portfolio manager/analyst in the emerging markets bonds team within Vontobel Asset Management's fixed-income boutique. The firm has $117 billion in assets under management.

"Last month's BRICS expansion was an investment non-event and will do nothing to spur any kind of global interest by international investors," said Damien Buchet, CIO at emerging markets manager Finisterre Capital. The firm has $3.6 billion in AUM.

The reason? These countries are, largely, uninvestable or unattractive for a number of reasons: Iran is subject to international sanctions, Ethiopia's debt is rated CCC, Argentina is suffering from hyperinflation and has elections in October, and Egypt "is currently a situational story, with a lot of challenges on both the fiscal and balance of payments fronts," he said.

"So in short, apart from Saudi Arabia and the UAE, all other countries in the expanded BRICS are either sanctioned, too small or highly distressed to reinvigorate investor interest in the BRICS. This holds true for equities too, as none of these countries, except Saudi Arabia, the UAE, and perhaps Egypt, have a normally functioning and accessible stock market," he said.

Saudi Arabia and the UAE are good credits, he said, "but remain very highly rated with little spreads, and have not highly extended U.S. dollar bond curves."

Other sources also highlighted the difficulties of investing in some of the new countries.

"We don't imagine that the political expansion of BRICS will be the driving force for a renewed interest in emerging market equities," said Fiona Manning, fund manager on the Premier Miton Emerging Markets Sustainable Fund.

"Not least because of the problematic nature of investing in some of the new invitees from both a sustainability and practical perspective," she said, also highlighting Russia and Iran's sanctions and the potential for Argentina's currency devaluation. Premier Miton Investors has £10.5 billion ($13.1 billion) in assets under management.

Beyond those concerns, managers also expressed doubt over the actual concept of the BRICS: an exclusionary group that goes against the grain of investing in emerging markets in the first place for diversification purposes.

"The core principle of emerging markets as an asset class lies in the capacity to offer diverse exposure to countries in various contexts and stages of development," said Maria Negrete-Gruson, managing director and portfolio manager on Artisan Partners' sustainable emerging markets team. "We firmly believe that isolating a select few nations within the emerging markets category undermines the very essence of diversification, ultimately harming both investors and the broader economic development of emerging markets." Artisan has $142.8 billion in AUM.

Manning agreed. "In terms of equity investment, the BRICS concept was, in our opinion, somewhat flawed. Why would an active investor choose to artificially narrow their investable universe? To pursue attractive risk-adjusted returns, it seems sensible to us to cast the net as wide as possible," she said.

The BRICS as a concept "evolved into a misguided notion that size is the paramount factor guiding performance in emerging markets. However, we have since recognized that larger economies such as Russia and China may carry geopolitical risks that smaller non-BRICS nations do not necessarily have," Negrete-Gruson said.

China accounted for about 18% of world GDP in 2022, according to calculations using World Bank data.

Artisan's team also believes that "the selection of new additions to BRICS is not based on objective measures and is likely politically motivated. There is limited economic cohesion among the six potential new member countries, which further diminishes the potential for the newly formed group to impact investment interests," Negrete-Gruson said.

Marcelo Assalin, partner, head of emerging markets debt at the about $62 billion William Blair Investment Management, agreed that "we should get used to a world where China will grow less and less, as economic growth declines there."

But on the positive side, "India is rising, and it's going to be one of the strongest economic (powers) on the planet in the next few years," and the country will play a more central role in creating a "corridor linking the Middle East, India and Europe — which can be an alternative to China's Belt" and Road initiative, he said.

Assalin also sees improved availability of funding to emerging markets countries with the expanded BRICS bloc.

"If it's well organized — which remains to be seen as (this is) a very heterodox bloc of countries spanning from democracies to autocratic regimes, so cohesion may be a bit challenging there — I believe one of the positive implications of this will be more available and perhaps more affordable funding for countries that have been having a difficult time financing in the marketplace," Assalin added.

Sources also cited talk of reducing dependence on the U.S. dollar as a potential driver and subsequent desired result of the BRICS expansion, but dismissed the idea that it will not be the reserve currency of choice anytime soon.

"The conversation around replacing the U.S. dollar as the reserve currency is pure fallacy — there is no competitor. Many of those countries export commodities – all of those are exported, traded and listed in U.S. dollars," Vontobel's Larose said.

"It does not matter if China and India buy Russian oil in renminbi or in rupee, because oil trades are natively quoted and hedged in U.S. dollar. The hedging is particularly important because 99% of the volume in oil future contracts is denominated in U.S. dollar and represents a multiple of the size of the spot market," he said.

For as long as that situation prevails, "oil prices in renminbi will stay nothing more than oil prices in U.S. dollar, multiplied by the dollar/yuan exchange rate. This is true for most of the energy, metal and agriculture commodities," Larose said.

Around 3% of global transactions are made in renminbi. Although that's an increasing proportion, "it is way too low for it to be able to claim leadership as the world's reserve currency anytime soon," Larose added.