Analyzing BRIC Allocations: India Seems the Most Promising

Includes: EEB, EWZ, FXI, IIF
by: Carl T. Delfeld

During the past year, investor interest in the so-called BRIC countries [Brazil, Russia, India and China] has skyrocketed with a commensurate rise in respective share prices.

Is it too late to jump on the bandwagon? What is the best way to invest in these countries and what allocations should be made to each country in the BRIC group?

Fund flows into BRIC countries have risen sharply during 2006 and these markets have bounced back nicely from the sharp June pullback. Interestingly, China has captured about half of all the net increases in investment from global equity managers. This BRIC mania has obscured three important basics about these markets.

The first is that these are, without a doubt, less developed emerging markets with commensurate volatility and risk. If you got carried away in 2006, take some money off the table – now.

Second, your strategy for investing in these markets should be long term. The whole idea is that over time these faster growing markets will translate into above average returns but there will doubtlessly be lags and bumps along the way.

Third, it would be a mistake to view these four countries as just four cogs in a wheel. Each country has its own strengths and weaknesses and will probably not move together.

Russia, for sure, and Brazil, to a lesser degree, are essentially commodity plays. Russian share prices are highly dependent on energy prices and since all other indicators such as political freedom, manipulation of foreign investment, cronyism and market reforms are going the wrong way, I am highly skeptical of this market.

Brazil offers more hope but is also dependent on commodity prices since they account for 40% of all exports. President Lula’s re-election this year may lead to more aggressive market reforms or a pullback which would inevitably lead to the familiar boom and bust cycle.

China and India are the most promising BRIC options. Both markets have been red hot and China is riding a super cycle of investment which may very well extend through the 2008 Olympics. It is clearly in the midst of building a world-class infrastructure in urban areas but the familiar risks such as its state-dominated economy, lack of any democratic reforms, and tensions in rural areas where the majority of Chinese still struggle might derail the prized “stability” so touted by the Communist leadership.

My view is that India over the long haul presents investors with the great bull market of the 21st century. India however, also faces daunting challenges such as how to finance the modernization of its woeful infrastructure given its high debt levels and ambivalence towards foreign investment and privatization. Another key issue is timing. Large cap Indian companies have had a terrific run and seem quite expensive at about 20 times earnings. If earnings stay strong in 2007, the market could strengthen, but if not, expect a sharp pullback.

The best way to invest in these BRIC countries is probably through low-cost, flexible, transparent exchange-traded funds [ETFs] and their kin - closed-end funds. Claymore introduced the first BRIC ETF this fall (NYSEARCA:EEB) which tracks liquid U.S. exchange-listed ADRs and GDRs. It should, however, be avoided since its top ten holdings account for 57% of the ETF’s total exposure. In addition, 49% of its holdings are in Brazil, 31% in China, 14% in India and 6% for Russia.

You would be better off to make your own BRIC allocations based on your risk profile and investment objectives using country specific funds. One option is to use the China iShare (NYSEARCA:FXI), the Brazil iShare (NYSEARCA:EWZ) and the Morgan Stanley India Fund (NYSE:IIF) as proxies for these markets. Barclay's is planning an ETN that will follow an index of the largest companies on the National Stock Exchange of India but this ETF will be market cap weighted.

I will wait to see the company weightings but will probably still prefer IFF because of its nice balance with the inclusion of several well respected Indian subsidiaries of world class multinationals such as Siemens and ABB. You need to carefully watch the premium that a closed-ended fund trades relative to its net asset value.

Where would I be right now in terms of a BRIC allocation? About 30% for China, 20% for India, 15% for Brazil, zero for Russia and 35% in cash.

Disclosure: Author is long above-mentioned ETFs

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