BRIC ETF Investing 101

With sluggish growth forecasted for the next few quarters and an unemployment rate quickly approaching 10%, many U.S. investors are looking beyond their borders for new investment opportunities. While developed European and Asia Pacific economies have received a significant amount of attention, the most popular investment destinations remain the four largest emerging market countries: Brazil, Russia, India, and China, collectively known as the “BRIC” economies. Together, these four countries currently comprise 40% of the world’s population and 15% of GDP, ensuring that they will be a force to be reckoned with on the global stage for years to come. Meanwhile, combined foreign reserves total over $3.1 trillion, potentially allowing these countries to influence world trade and push politics more towards a multipolar world.

Historically, it has been difficult for many American investors to access BRIC equity markets directly; most have relied primarily on the few stocks that trade as American Depository Receipts (ADRs) on the U.S. exchanges. While the rate of ADR listings has increased considerably in the past decade, these securities have been tilted towards giant foreign firms with a heavy weighting to Chinese equities. However, with the rise of ETFs, investors now have the opportunity to efficiently access the equity markets of all four countries with a single low cost fund. There are a number of BRIC ETFs offering exposure to these developing economies, each of which provides slightly different exposure to these future economic juggernauts.

BRIC ETFs

There are currently three ETFs exclusively following the BRIC region: SPDR S&P BRIC 40 (BIK), Claymore/BNY Mellon BRIC ETF (EEB), and iShares MSCI BRIC Index Fund (BKF). While the three ETFs may track the same countries, their respective weightings are very different. As presented in the chart below, the weightings vary significantly between the three funds for their country allocations:

Country	EEB	BKF	BIK
Brazil	54.4%	33.3%	28.4%
Russia	3.7%	13.3%	21.3%
India	11.1%	15.9%	6.1%
China	30.8%	36.3%	44.2%
Source: ETF Fact Sheets as of 9/30/2009

So there is significant variation in the country weightings given to each of the four BRIC countries between these funds: BIK has almost 6 times the “R” as does EEB, while BKF has twice the “I” as BIK. This gives investors options – those looking to steer clear of India and Russia may prefer EEB, while those looking for more balanced exposure may find BKF more attractive.

A further breakdown of the three funds is shown below. All three of the funds have similar expense ratios and, despite the variances in country allocations, comparable year to date returns. Major differences between these ETFs are the dividend yields and the concentration of funds in certain sectors. BKF has the lowest dividend payout and the smallest exposure to the energy sector (giving the largest weighting instead to financials).

	EEB	BKF	BIK
Expense Ratio	0.60%	0.72%	0.50%
Dividend Yield	2.64%	1.29%	2.86%
YTD Return	75.6%	77.2%	74.0%
Top Holding	Petrobras (PZE)	Petrobras	Gazprom (OGZPY.PK)
Top Sector (as of 9/30)	Energy (27.0%)	Financials (28.1%)	Energy (37.2%)

BRIC ETF Price Drivers

There are several factors that affect the prices of BRIC ETFs including:

• Monetary Policies: In the past there has been significant mismanagement of emerging market currencies, but that has changed in recent years due to the large current account surpluses and huge stocks of gold and foreign currency reserves. If these policies continue, continued stability in emerging market currencies could allow the BRICs to mount an attack on U.S. Dollar hegemony in the near future, further tipping the economic scales in their favor.
• Export Levels: Many of the BRIC countries depend on their exports to fuel their continued growth. If the dollar doesn’t collapse and exports do not cause their respective currencies to rise too quickly, these exports will be a continued boon to the emerging markets, especially Brazil, Russia and China, which have become much more dependent on exports in the past decade.
• Geopolitical Tensions: Each of the BRICs has their own geopolitical issues. Brazil is arguably in the best position, isolated from other major powers in South America. However, should tensions rise between Venezuela and the West, it could drag down Brazilian equities (especially if America views Brazil as taking a neutral role in any conflict). Russia is constantly worried about continued threats from terrorism in Chechnya, while India is concerned over a volatile relationship with Pakistan. China has its own issues with North Korea and internal tensions among different ethnic groups. Should any of these tensions spiral out of control, it could mean trouble for equity markets.
• Country Stability: While an issue in the past, all four of the BRICs have come a long way in terms of providing a stable environment both for their citizens and foreign investors. While the degree of democratic participation may not be up to Western levels, especially in China and Russia, it is hard to argue with the fact that these countries have taken big steps forward. If conditions continue to improve and investor protection is further enhanced, it could mean lower risks.
• Trade Barriers: Tensions between China and the U.S. have ratcheted upwards as of late due to tariffs and fears over currency manipulation. There have been similar fears with ethanol in Brazil, workers from India and tensions between Russia and America over how to deal with Iran. Should any of these situations turn into a full blown trade war, both sides could be heavily impacted.
• Increased Consumption: As the BRIC economies continue to grow, their populations will become wealthier and will be able to afford the goods that they have produced for the West. If this happens, the BRICs could become virtually self-sustaining economies and “decouple” from American economic events. Should that happen, the BRIC countries could become an even more important tool for diversification and an even bigger part of American investors’ portfolios.
• Market Interventions: Many of the BRIC countries have significant government intervention into the economy or own large parts of the economy outright. While most countries have heavily intervened in their respective countries in the past year, emerging market or not, some investors remain frightened of doing business in the BRICs due to Byzantine rules and regulations and heavy subsidies towards state owned companies.

Leveraged and Inverse Investment Ideas

While there are no pure play leveraged or inverse ETFs in the BRIC category, there are several funds that can be used as a proxy for a leveraged BRIC fund due to their significant weightings in the BRIC countries. Unfortunately, they all track the same index, the MSCI Emerging Markets Index, and all have a 47.59% weighting in the BRIC countries.

• ProShares Ultra MSCI Emerging Markets Fund (EET): tracks double the daily return of the MSCI Emerging Markets Index.
• Direxion Emerging Markets Bull 3X Shares (EDC): tracks triple the daily return of the MSCI Emerging Markets Index.
• Direxion Emerging Markets Bear 3X Shares (EDZ): tracks triple the inverse daily return of the MSCI Emerging Markets Index.
• ProShares Short MSCI Emerging Markets Fund (EUM): tracks the daily inverse return of the MSCI Emerging Markets Index.
• ProShares UltraShort MSCI Emerging Markets (EEV): tracks double the daily inverse return of the MSCI Emerging Markets Index.

Sector-Specific Investment Options

BIK, BKF, and EEB offer diversified exposure to BRIC economies, investing in all sectors of these economies. Emerging Global Advisors has launched a line of sector-specific emerging market ETFs that have heavy allocations to BRIC countries. EGA’s products include:

• Emerging Global Shares Composite Fund (EEG)
• Emerging Global Shares Metals & Mining Fund (EMT)
• Emerging Global Shares Energy Fund (EEO)
• Emerging Global Shares Financials Fund (EFN)

Further Reading on BRIC ETFs

Read the report that started the BRIC phenomenon (PDF file), as well as other reports on rapidly industrializing economies from Goldman Sachs.

Disclosure: No positions at time of writing.

Comments

[Mad Hedge F...:]

mdae I’ve got to comment on Brazil’s (EWZ) idiotic move last week to impose a 2% tax on real stock and bond purchases to scare off foreign investors. It’s like firing off an emergency flare in the night and saying “Come and get me.” If any portfolio manager was living in a cave for the past ten years and somehow missed the attractions of investing in an emerging market that exports food and energy, has an appreciating currency, and an almost perfect demographic profile, they can see it now, clear as day. This lunacy reminds me of Malaysia prime minster Mohamad Mahathir’s rantings and ravings about George Soros’s selling of his country’s markets during the Asian financial crisis, when in fact, George was buying. I sympathize with Brazil’s dilemma, similar to those of the Swiss during the eighties and nineties, when the whole world wanted to buy their currency, forcing the government in Berne to drive interest rates to zero, pushing domestic prices through the roof. But this is the price of economic success. Everyone wishes they had Brazil’s problems. Better to just let things be.

Oct 28 04:31 PM