The Global Guru: Why Has BRIC Investing Been Such a Bust?

Few financial concepts caught on as quickly as “BRICs,” which stand for Brazil, Russia, India and China, the “Big Four,” fast-growth economies in the world today. Goldman Sachs economist Jim O’Neill coined the phrase in 2003, and it now has come into widespread use as a symbol of the shift in global economic power away from the developed G7 economies toward the developing world.

Together, the BRICs encompass more than 25% of the world’s land mass and 40% of the world’s population. The BRICs today already account for a combined Gross Domestic Product (GDP) that already exceeds that of the United States. And thanks to their rapid growth, by 2050, the BRICs could eclipse the joint economies of the current richest countries of the world. Goldman Sachs projects that the Chinese economy alone will overtake the United States by 2027. And with India accounting for 10 of the 30 fastest-growing urban areas in the world and 700 million people moving to cities by 2050, its influence on the world economy will be bigger than Goldman Sachs thought in 2003.

With such glorious prospects, it is no wonder that investors poured money into the BRIC stock markets over the past five years in the expectation that their profits would echo the rise to global prominence of these newly dominant economies.

Alas, things did not quite turn out that way.

Negative Local BRIC Sentiment: A Bullish Sign?

On the ground, the negative sentiment among local investors in the BRICs is as lousy as it has been in recent memory. Even as the Dow is trading near an all-time high, the MSCI BRIC Index remains 37% below its 2007 peak.

No wonder local BRIC investors are pulling in their horns.

In Brazil, trading by individual investors has dropped to its lowest level since 1999. Locals are disappointed by the performance of former market darlings like Petrobras (PBR), which has lost 64% during the past five years. This offshore drilling pioneer was once the eighth-largest company in the world. Today, it barely cracks the top 50.

In Russia, Vladimir Putin’s meddling with listed companies – particularly in the oil sector – has made local investors cautious. That’s why Russian mutual funds have seen 16 straight months of outflows — the most since at least 1996.

The story is similar in India. There, local mutual funds recorded nine-straight months of outflows through February, with about 135 billion rupees ($2.5 billion) taken out of the market.

In China, the number of Chinese stock accounts dropped by about 2.3 million over the past 12 months. And can you blame them? The Shanghai Composite (SHCOMP) has tumbled 31% since the end of 2009, making it the single worst performer among the BRICs.

How To Best Play Emerging Markets

On the one hand, you could take all of this “head in your hands” negativity as a contrarian indicator. After all, the MSCI BRIC index trades at a price-to-earnings (P/E) ratio of 9.2 — a 30% discount to global markets. That’s the cheapest they’ve been since July 2009.

On the other hand, lousy fundamentals support the current negative sentiment. According to Bloomberg, more than 59% of companies in the MSCI BRIC index reported disappointing quarterly earnings last quarter — for the fourth quarter in a row. This has made BRICs cheap. But it has not made them attractive.

Up until recently, the most common way for you to invest in emerging markets is through emerging market exchange-traded funds (ETFs) like the Vanguard FTSE Emerging Markets (VWO) and iShares MSCI Emerging Markets (EEM).

The trouble is that as market-cap weighted indexes, these indexes always have been very “BRIC heavy.” In fact, BRICs account for approximately 44% of the MSCI Emerging Markets Index.

It was while I was reviewing the performance of my “Ivy Plus” Investment Program at my firm Global Guru Capital in 2013, that I realized that 2013’s slow-starting emerging markets did not apply to emerging market small cap stocks. The program’s allocation to emerging market small caps through the Wisdom Tree Emerging Markets Small Cap Dividend Index (DGS) has risen 4.17% so far this year, outperforming the iShares MSCI Emerging Markets Index Fund (EEM) by over 7% in just two-and-one-half months. That’s also why I recently recommended DGS in my monthly investment service, The Alpha Investor Letter.

Unlike its mainstream counterparts, the WisdomTree Emerging Markets SmallCap Dividend Index (DGS) invests in privately owned (as opposed to state-directed) companies that are driven by domestic demand, like consumer-related companies, industrials, real estate and financial services. As a result, the index consists of small-cap stocks in emerging markets that you could never invest in otherwise.

Better than the Legendary Sir John Templeton

Since its inception, the WisdomTree Emerging Markets SmallCap Dividend Index has strongly outperformed the more mainstream iShares MSCI Emerging Markets Index Fund (EEM), ranking ninth in a group of 258 U.S. ETFs and open-end mutual funds in the diversified emerging markets category. And just look at how DGS has outperformed the Templeton Emerging Markets Fund — managed by emerging markets guru Mark Mobius — over the past two years.

So follow the recommendation I gave recently to my Alpha Investor Letter subscribers. Buy the WisdomTree Emerging Markets SmallCap Dividend Index (DGS) at market, and place your stop at $48.00.

P.S. I’ll be spending this week in Dubai at the CFA Institute’s annual Middle Eastern Investment conference. As you may know, Dubai is an isle of remarkable stability in the Middle East, best known for its remarkably ambitious construction projects like the world’s tallest building — the Burj Khalifa and the Palm Jumeriha. I’ll share my impressions of Dubai with you in next week’s edition of the Global Guru.

To read my e-letter from last week, please click here. I also invite you to comment about my column in the space provided below.