May 2009

BRIC ECONOMIES: Bright young things

While the global recession is no doubt affecting the Bric economies, they are proving more resilient than the West. There is no mistaking a significant shift of power towards the newer international markets, says Fiona Rintoul For Alan Nesbit, fund manager of the First State Latin America fund, there is no better illustration of the rising power of the leading emerging markets that make up Bric (Brazil, India, Russia, China) than US brewer Anheuser Busch’s Brazilian ownership.

When Anheuser Busch, brewer of such iconic beers as Budweiser and Bud Light, first slipped into foreign hands in 2008 he reaction in the firm’s home country was not entirely positive. One commentator described the sale as “a national disgrace”.

People like this have to get used to the fact the world is changing, suggests Nesbit. “You often have very old stodgy management in mature countries,” he says. “Many companies in emerging markets are run by very savvy people.”

The future is the young, smart, savvy management found in the emerging markets, where you have to be strong to survive, is Nesbit’s message. The fat-bottomed oldsters in the comfortable and ageing developed markets are the past.

Of course if you ask a barber if you need a haircut, he will say yes. It is therefore perhaps unsurprising that emerging markets specialists talk up the emerging markets – and the firms that are growing up there.

But there is broad agreement that the axis of economic power is shifting away from the US, Western Europe and Japan towards these newer markets. And the numbers are compelling. Although the World Bank has trimmed its 2009 economic growth forecast for China, growth is still predicted to reach 6.5%, while the economies of the US and other developed countries are shrinking.

Sharp market falls in emerging markets in the wake of the global financial crisis may have posed questions, but many feel these have been answered by the subsequent recovery. Stock markets in emerging markets are all in positive territory since their low points, notes Franklin Templeton Investments’ emerging markets guru Mark Mobius. Brazil has risen 37% from its low, Russia 55%, China 35% and India 43%, he says.

Rapid recovery
“Recovery has been very rapid,” says Mobius. “Emerging markets generally have fared very well during the financial crisis because their debts in relations to GDP are low and their foreign reserves are high.”

Most, like Brian Deacon, head of emerging markets at Fortis Investments, see China as the lynchpin. “There’s an argument that China will become more important than the US in the very near future,” he says.

Because China is a major commodities importer, this growth will benefit commodities exporters such as Brazil and Russia, as well as exporters outside Bric, such as Chile and Peru. The latter will benefit in particular from China’s drive to build up its copper reserves, says Deacon.

China’s growth could also help the global economy in the long run, suggests Martin Lau, director of Greater China equities at First State Investments, though he also offers a reality check. “In the short term it is difficult, given the sheer difference in size of the economy  compared to the US, Japan and Europe,” he says. “The US is still 40% of global GDP and US consumption is 25% of global GDP.”

This brings us to two key questions. First, does Bric make sense as an investment universe? Secondly, does the ‘decoupling’ theory still have any credence: that is, can these markets thrive while the developed world goes to Hell?

Answers to both questions are mixed. For Bill Rudman, a director at emerging markets specialist Blackfriars Asset Management, the Bric concept does not make philosophical sense, but does make commercial sense – or did.

“When Bric started to happen, we stood back because we preferred to have a menu of 22 countries,” he says. “In retrospect that was a commercial mistake. Now it may be a phenomenon that’s played out. Even Goldman Sachs, who invented it, reinvented it last year when it started looking at the N-11, next eleven.”

By contrast, Martial Godet, head of new markets at BNP Paribas Investment Partners, sees an internal logic in Bric.
“Bric is a very good investment vehicle,” he says. “You have a mix we feel is good. You are long and short commodities. India and China tend to underperform Brazil and Russia when commodity prices are up and the reverse is also true.”

Decoupling also provokes debate. Mobius says: “We have never subscribed to the decoupling theory since it is clear that because of improved trade and communications, events in one part of the world will impact other parts of the world.”

But it is surprising how many commentators continue to believe in decoupling. For Peter Lucas, investment strategist at RBC Wealth Management, it is very much on the agenda as a long-term theme.

“I do believe decoupling will return as a major theme,” he says. “If you look beyond the credit crunch to what happens next, it’s not clear that cuts in interest rates will work in the developed world, but in China where debt levels are not impaired they are having spectacular results.”

Alex Ingham, emerging markets fund manager at Aviva Investors, also believes that decoupling is not dead, with the difference between “those economies that have run sensible policies” and the rest starting to be felt.

“They [Bric] can’t be totally decoupled but they’re not nearly as dependent on the developed markets as they used to be,” says Ingham. “China is better able to steer its own course. It’s better able to produce growth with out export growth.”

Perhaps it’s a question of definition. Godet says he has never seen a satisfactory definition of the term. “It depends on your time horizon. I believe growth will be significantly higher in these countries for a long time and muted in the developed countries for some time.”

And in many ways Mobius agrees with Ingham. Rejecting decoupling does not mean that if one country falls into recession another must do so as well, he notes.

Domestic consumption
“While the US and other developed countries are seeing their economies shrink, the Chinese economy is growing. That does not mean that China has not been impacted by the US slowdown.  Of course Chinese exports to the US have been impacted, but domestic consumption in China and trade with other countries is making up for that loss.”

Indeed, most commentators believe it is domestic consumption stories that will provide the most stable growth opportunities as these markets develop. This is one reason (along with poor corporate governance) why prospects look somewhat bleaker in Russia than the other Bric markets. 

“Russia has had a more difficult time than China, India and Brazil because of its heavier reliance on raw materials exports such as oil and gas,” says Mobius. “In the case of the other three countries, their economies are more diversified with large domestic consumption.”

In India, the most internally driven market in Bric, a big theme is the emerging middle class. Aviva’s Ingham targets this through, for example, Colgate India. In China, big themes are industrialisation and infrastructure spend. Retail consumption has also been rising, but there is a question over whether growth can be maintained.

“We feel the key will be whether retail consumption growth can be sustained in double digits,” says Lau. “We believe in the medium term that China should try to move into a more consumption-driven model, as consumers do have plenty of money to spend. However, this will not happen overnight due to culture and lack of a good social security net.”

Meanwhile, in Brazil, First State’s Nesbit also looks for domestic themes. The main thing to understand about Brazil is that it has everything China wants, Nesbit says. This has had enormous benefits in the domestic economy, and he prefers to play the commodities story through these domestic themes.

Does the future of these markets then depend on what happens internally? Even decoupling believers don’t see it quite like that.

“Poor recovery trends in the developed markets would mean a lower growth outlook for everyone,” says Ingham. “For a more severe negative we would need to see the developed world go into a depression scenario.”

Other negatives do reside internally. An unclear result in the forthcoming Indian elections could cause problems, while some see dangers in China if unemployment continues to rise.

“We feel that the prospect of social unrest is a major concern and has become a greater threat with rising unemployment,” says Lau.

But whatever the potential problems, the bottom line will be how these markets stack up against their developed-world counterparts. In these uncertain times, they stack up well, says Godet.

“Given the critical state of the world economy I don’t see how it could get much worse. Even if the crisis goes on longer than predicted that would primarily be bad for developed markets. We still favour emerging markets relative to developed markets.”

©2009 funds europe

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