The Demise of the BRICs?

It's the end of an era ... and perhaps a sign of the times. Fourteen years ago, Goldman Sachs coined the acronym BRIC to label the fastest-growing emerging markets of Brazil, Russia, India and China and to forever group them together for better or worse. Now Goldman has pulled the plug on the BRIC dream by shutting down its own BRIC-focused investment fund after several years of poor returns prompted asset outflows. Could this also be a contrarian buy signal for the BRICs?

The BRIC saga holds an important lesson for investors: The persistent power of mean-reversion in markets. That's a fancy, statistical why of saying: What goes up must come down, and vice versa.

In the 10 years after Goldman economist Jim O'Neill wrote the book on BRICs in 2001, these markets were all the rage. The BRIC countries grew rapidly in economic stature, now accounting for 20% of total global output.

Rich investment gains followed, with the MSCI BRIC Index surging 308% during the 10 years ended 2010, compared with a paltry 15% gain for the S&P 500 Index.

But just as investors were jumping aboard the BRIC bonanza with both feet, the cycle turned ... with a vengeance.


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BRIC growth inevitably slowed. And over the past five years, the BRIC stock markets have lost 26% of their value, compared with a 92% gain in the S&P 500. Since 2010, funds investing in BRICs suffered massive capital outflows of more than $15 billion.

Goldman's own BRIC fund, which attracted $842 million at the peak, lost nearly 90% of its assets since 2010. And it was recently merged out of existence, by getting combined with one of the firm's broader emerging market funds.

While Goldman is getting more generic with its emerging-market fund offerings, you should think about doing the exact opposite.

Investors today are better served by digging a bit deeper into specialized funds that target specific emerging-market countries, including the BRICs, because that's where the best opportunities can be found.

 

In last week's Money and Markets article I pointed out that money was finally beginning to flow back into emerging-market ETFs after persistent outflows in recent years, but here's the rest of the story.

While generic emerging market ETFs have indeed suffered asset outflows of $6 billion over the past three years, single-country emerging-market ETFs have collectively attracted $7 billion of asset inflows!

Investors are simply getting more selective about where they invest in the wide world of emerging markets, and you should too.

After all, emerging markets, like the BRICs, were never intended to be a monolithic asset class. Just as investors should differentiate between technology stocks like say, Adobe (ADBE) and Apple (AAPL), you should also differentiate between investing in India versus Ireland.

There may not be a whole lot of difference between two ETFs that both track U.S. stock indexes, but there's a world of difference between investing in the PowerShares India ETF (PIN) and the iShares MSCI Ireland ETF (EIRL). Here's what I look for in a single-country ETF with solid upside potential.

First, follow the money. Most ETF websites include stats about fund flows — the amount of money that's moving into or out of the ETF over the past few months. If not, you may have to dig a bit deeper and read the ETF prospective, which always includes the money flow statistics.

Look for ETFs with positive money flow trends, or better yet, where the trend has recently shifted from selling
to buying.

It's always best to go with the flow and follow the money once it begins to consistently flow into and ETF while it's still cheap, and best of all, while it's still unpopular.

The good news is that most emerging markets are unpopular today, if not hated by investors. From a contrarian perspective, that's music to my ears. But how do you gauge whether an ETF is still cheap?

Second, a good rule of thumb to use is the PEG ratio. That's the price-earnings ratio compared with the expected growth rate of earnings. This is a good measure for valuing individual stocks that Peter Lynch popularized decades ago.

The idea is to select stocks with the lowest PEG ratio, and preferably a ratio below 1.0. These stocks have earnings growing faster than the P/E ratio implies. For instance, a stock selling at 15 times earnings, but with 20% profits growth. That's a bargain.

The PEG ratio works just as well valuing single-country ETFs to help you determine if an entire stock market is cheap or expensive.

The table above includes a select list of emerging-market countries that fit the bill. In many cases there are multiple ETFs tracking these countries. Perusing the table, you can see several that really stand out as potential bargains with three things in common:

#1: Money is flowing into these countries,

#2: Cheap P/E ratios, much lower than the U.S., and

#3: Earnings are growing at a rate faster than the P/E ratio implies!

India's stock market — the "I" in BRIC — has a forward P/E ratio of just 14.3 times earnings yet India's corporate profits are expected to grow 16.5% over the next year.

Staying in Asia, Vietnam's market has a P/E less than 13 times earnings with projected profit growth of 14.6% and 16.7% over the next two years. And South Korea has a P/E of just 11, but earnings growth of 13.2%.

You can find bargains in emerging Europe too. In Poland, stocks are priced at just 14 times earnings with profits growing 21.8% over the next year. These all look like bargains in my book. 

Even though the heyday of BRIC investing may be over and emerging markets in general are unloved, if you're willing to do your homework and drill down to the individual component countries, you'll find some real gems!

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