Bric becomes a game of two halves

In the past investing in the Brics, whether through an exchange traded fund (ETF) or actively managed fund, made sense as a way of backing the rising economic stars of the future. But now all four countries are carving out very divergent paths, it might be time for investors to get more selective.

Bric has always been a game of two halves, with Russia and Brazil more commodity-dependent and structurally weaker than India and China, but 2014 was the year those differences really hit home, meaning the time to back the whole group could be over. Over the year the MSCI Emerging Markets index returned 3.9 per cent. However, the MSCI Russia index fell by 42.9 per cent and MSCI Brazil returned a negative return of 8.7. In contrast, the MSCI China index returned 14.7 per cent and India 31.6 per cent.

Even the man who hailed the birth of Bric is turning on his own acronym. Former Goldman Sachs Group chief economist Jim O'Neill coined the acronym in 2001, arguing that over the next two years real GDP growth in large emerging market economies would exceed that of the G7. When he first hailed the rise of the Brics, GDP on a PPP basis in Brazil, Russia, India and China accounted for around 23.3 per cent of world GDP.

But earlier this month he said he might be tempted to "call it just IC" for the next few years and "if the next three years are the same as the last for Brazil and Russia I might in 2019".

So what changed and what does it mean for investors? The downwards trend set in with the 'taper tantrum' in 2013, when then US Federal Reserve Chair Ben Bernanke signalled that the Fed's massive monetary stimulus package could be scaled back sooner than expected, causing a jump in Treasury yields. The threat of reduced liquidity acted as a wake-up call for emerging markets with hefty current account deficits, exposing the scale of domestic reforms needed to support future growth.

Financial Express analyst Charles Younes says: "It was in May 2013 that we started to realise that the mantra around emerging markets was hype from the years before. Growth over the past 10 years was based on an economy super cycle, very low rates and a flood of foreign investment because those countries were so cheap.

"When the tapering talk started they were left with reduced investment and huge domestic reforms to do. In the last two years we've moved away from emerging markets being the new economic giants ready to take over the growth in the economy and now we're talking of the fragile five and the suspect six."

Oil and politics

Domestic politics and the plummeting oil price were also key drivers of the Bric split in 2014. The lower oil price has served as a tax break for oil-consuming Chinese and Indian populations, while China and India continued to make headway with large-scale reform and new political agendas.

India's election of enterprise-friendly Narendra Modi, who stormed to victory with his Bharatiya Janata Party in the country's election in May, caused a surge in investor confidence. Meanwhile China took another step towards a more open economy, launching The Shanghai-Hong Kong Stock Connect scheme at the end of 2014, which allows foreign investors to trade Shanghai-listed A-shares for the first time.

In contrast energy exporting nations Brazil and Russia saw markets tumble in response to the plummeting oil price.

In Brazil, the re-election of Brazilian president Dilma Roussef was also accompanied by scepticism over her ability to stop rising rates of inflation and a widening fiscal deficit. The country experienced a trade deficit of $3.93bn in 2014, the largest since 1998 and exports dropped 7 per cent over that period.

Russia loses around $2bn in annual government revenues for every dollar fall in the oil price and earlier this month dramatically hiked its interest rate to 17 per cent to shore up its troubled currency. Escalating tension between Russia and Ukraine sent also markets crashing in those regions.

However, according to Coutts, Russian equities are looking oversold - in December the MSCI Russia index was trading at 0.4 times its book value according to the investment bank. That's a 70 per cent discount to emerging markets as a whole and a more bearish position than even the low of 0.6 during the credit crunch.

There is also chance for a Brazilian resurgence. Latin America analysts at Goldman Sachs say "the country has tremendous potential but is still trapped by the idiosyncrasies of recent policies."

Bad times for Bric funds

Nervousness surrounding the Bric economies has been echoed by a lack of appetite for Bric funds.

The MSCI Bric index has a 7.79 per cent weighting to Russia and 21.62 per cent to India and has not fared well over the past five years, delivering negative returns in 2014, 2013 and 2011. That meant that ETFs following the index saw similar returns, with db x-trackers MSCI Bric UCITS ETF, one of the cheapest, returning -3.83 in 2014 and -4.38 the previous year.

Among actively managed funds, Allianz BRIC Stars (GB00B0WDH725) was the standout performer in 2014, returning 8.2 per cent compared with a negative return of 2.85 for the MSCI Bric index. However, the three previous years were not as positive, when it failed to beat its benchmark - and over a five year cumulative period the fund returned a loss of 9.91 compared with a 9.26 return for the benchmark.

Neptune Russia & Greater Russia (GB00B04H0T52) plummeted 46.51 per cent in 2014, falling 43.07 over a cumulative five-year period. The fund's top holdings are in Norilsk Nickel and Lukoil, both of which suffered large share price drops at the end of last year.

The IC without the BR

China and India are now the most popular emerging markets for investment and with good reason. According to Morningstar, India is the most popular emerging markets country because of its favourable environment for enterprise. However, Christopher Aldous, the managing director of Pan Asset warns: "India is a great long term story but it's certainly not a bargain."

IC Top 100 fund New India Investment Trust (NII) is our preferred choice for active investors. The trust invests in companies incorporated in India or deriving significant profit from India and has a quality bias which mitigates market risks. Total fees are capped at 1.75 per cent and last year the fund beat its index by 23.07 per cent, returning 54.65. The fund's largest exposure is to finance followed by IT, which makes up 18.7 per cent of the portfolio.

For passive exposure to India, the Amundi ETF MSCI India UCITS ETF EUR (C12) has effectively tracked the MSCI India index on an annual basis, though its cumulative returns have been lower at 25.85 per cent over five years compared with 34.35 from the index. It is also relatively cheap, at an ongoing charge of 0.80 per cent.

Passive exposure to China is booming, with a proliferation of new funds in the wake of the Shanghai-Hong Kong stock connect launch last year. Growth in the country has slowed in recent months but analysts are confident in the long-term potential. The CSI 300 index tracks the most liquid A-shares stocks and products like db x-trackers Harvest CSI300 Index UCITS ETF (RQFI) offers exposure to it.

IC Top 100 fund JP Morgan Chinese Investment Trust (JMC) has beaten the MSCI Golden Dragon benchmark over a three, five and 10-year period. However, the fund was patchier last year, offering a total return of 11.40 per cent in 2014 compared with the benchmark's 14.39. It is currently trading at a discount of 11.46 per cent.

Another good option is Fidelity China Special Situations Fund (FCSS), which we tipped as a 'buy' earlier this month. It is currently trading at a discount to its underlying net asset value (NAV) of 12.24 per cent and has a market cap of £771m, making it larger and theoretically more liquid than JPMorgan Chinese. It has also outperformed this trust over one and three years.

Beyond BRIC

"If investors are happy to do the research and choose individual companies, I'd urge them to look beyond just the Bric countries," says Hargreaves Lansdown's passive investment manager Adam Laird. "While these large countries are hugely important and have provided good returns for investors, you could easily miss other appealing areas." For Mr Laird that means Turkey, where the government has just lowered interest rates to aid indebted businesses. He points to UBS ETF MSCI Turkey UCITs ETF (UB36), one of the cheapest funds with an ongoing charge of just 0.43 per cent but warns: "Be wary when investing in Turkey - Turkish ETFs can have very wide spreads, which can be costly for short-term investors."

Another option is to invest in a region such as Asia. Mr Aldous is keen on emerging Asian debt funds, which incorporate Indonesia, another emerging market beneficiary of oil price drops. An ETF like HSBC MSCI Indonesia UCITS ETF (GBP) (HIDR) offers access to large Indonesian equities for a relatively low ongoing charge of 0.60 per cent. As it physically replicates its index, any third-party risk involved in synthetic products is cancelled out.

Chinese and Indian fund performance (annual total return %)

*Source: TrustNet as at 23 January 2015. ** Source: Deutsche Bank AG, from Jan 8 2014 - Jan 8 2015

Index performance (cumulative total return %)