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Brics: cheap, risky or worth a bet?

Are Brazil, Russia, India and China an appealing investment or is it time to ditch your Bric?
January 14, 2016

Since we last looked at the so-called Bric economies of Brazil, Russia, India and China a year ago things are looking decidedly shaky. Since January 2015 the oil price has sunk to new depths and the bubble in Chinese equity prices has burst dramatically. Brazil, meanwhile, is mired in scandal and clamours for president Dilma Rousseff's impeachment have gained force. So are any of these volatile markets worth investing in today?

China - the eye of the storm

The bursting of the Chinese equity bubble sent shockwaves rippling through global markets, resulting in the Chinese authorities suspending market trading just minutes after opening last week. In January last year commentators were still bullish on China's potential, with the recently launched Shanghai-Hong-Kong Stock Connect programme spreading optimism. Months later a combination of weak growth data and the surprise devaluation of the Yuan resulted in panic selling and a market rout in August. Last week markets plunged again, kicking into action circuit breakers designed to suspend trading in the event of a market fall of 5 per cent. That followed another round of currency depreciation, spooking already jittery investors who piled out of Chinese equities.

Between 28 January 2014 and 28 January 2015 the CSI300 index had risen 72.71 per cent in pounds sterling. So far this year it is already down 12 per cent.

Fund managers have been quick to point out that the worst affected area is the domestic Chinese market, which UK investors will not be as exposed to as offshore markets such as Hong Kong. But all markets have experienced some turbulence.

The worst affected funds have been those with large holdings in domestic China-listed A shares, such as Fidelity China Special Situations (FCSS), which has over 21 per cent of its assets in A shares. This IC Top 100 Fund's share price has been moving with the market and is down 8.15 per cent in the year to date.

But a host of other China, Asian and emerging market funds are also affected by the rout, and few have been left unscathed. Jason Hollands, managing director at Tilney Bestinvest, says: "Slowing global growth with China at its epicentre, and disinflationary pressures alongside continued high levels of government and consumer debt constraining consumption growth, combine to make a cocktail of concerns in the outlook for 2016."

But Matthew Sutherland, investment director for Asian equities at Fidelity, says: "China's growth is slowing, but the quality of that growth - more consumption and less debt-fuelled investment - is far more important, and the difficulties are more than discounted in cheap valuations. And for equity investors, the really good thing is that the Chinese stock markets are very broad, which enables us to find lots of great bottom-up ideas irrespective of the macro environment."

Due to the stellar performance of China funds throughout 2014, and through 2015 until their July high, you should still be sitting on double-digit returns if you had invested in the best funds three years ago. Invesco Perpetual Hong Kong and China (GB0033028332) has returned 25.7 per cent over that time and Fidelity China Consumer (GB00B6WFC751) has returned 23.6 per cent. But the future looks murky and funds have been giving away returns since the bubble burst. In one year both are down by more than 5 per cent and there is little guarantee that even good stockpickers will be able to weather the coming storm.

 

Russia: cheapest but least appealing

Russia already looked unappealing in January last year as the falling oil price hit the region, and last week Brent Crude sank below $33 a barrel for the first time since 2008, clouding the outlook for the region even more. Russia is now one of the cheapest markets around: according to Canaccord Genuity, at the end of September 2015 MSCI Emerging Markets Index was trading at a cyclically adjusted price-earnings multiple of 12.8 times while Russia traded at just 4.7 times. MSCI Russia Index is also now trading on a price-to-book ratio of 0.56, making the market cheaper than the sum of its assets.

The Russian index actually returned positive results in 2015 as a whole. This was mainly due to the depreciating rouble, which plummeted in the latter half of the year after a brief rally, and partly due to Russia's actions in the Middle East, which caused a brief improvement in investor sentiment.

But those gains - generally under 10 per cent over a year - won't do much to reward investors who went into the market three and five years ago. HSBC GIF Russia (LU0544978496) has lost 54.4 per cent in five years, Neptune Russia and Greater Russia (GB00B86WB793) and Pictet Russian Equities (LU0859479239) have also shed in excess of 50 per cent over that time, and all these funds have lost more than 38 per cent over three years. Exchang- traded funds (ETFs) tracking Russian markets have not fared any better. Over three years db x-trackers MSCI Russia Capped Index UCITS ETF (XMRC) is down by more than 50 per cent.

Luke Richdale, client portfolio manager in JPMorgan's Emerging Market equities team, says: "We are overweight Russia given its attractive valuation. History suggests that this level of undervaluation provides a floor for currencies, as it is extreme enough to prompt an economic adjustment with rates rising, the economy slowing and imports falling. This has proved true for Russia, with a stabilising rouble helping to make it the best performing major emerging market this year."

The yield on the Russian index is also high. James Butterfill, head of research at ETF Securities says: "The benefit of Russia is that it's a big proxy to the oil price and you are being paid to wait (for that to rise). The average yield is 5 per cent at the moment and that's attractive. I think in the first quarter at the least negative sentiment will prevail, while the second half is when things should start to recover and people should begin to look at fundamentals. At the moment we've reached peak bearishness in sentiment."

But yields can be deceptive. Investors putting their faith in a low multiple could be walking into a value trap. "Price to book is very cheap but only if you believe the book," says Mr Butterfill. "Yes, anything trading at 0.5 times book is exceptionally cheap, but given the recent capital expenditure cuts from Russian companies it might not be that accurate."

Like the index, Russian ETFs are on high yields and very low price-to-book figures. However that high yield reflects the high risk of dividend cuts and poor returns. HSBC MSCI Russia Capped UCITS ETF (HRUB) is on a yield of 5.67 per cent and a price to book of 0.45 per cent. In a year it has returned 4.1 per cent but over three years it has lost more than 40 per cent. Investing in Russia is an uncertain game.

"Yes, eventually there will be a trade in Russia when the oil price rises, but I don't know if I'd really call that investing," says Gary Greenberg, head of Hermes Emerging Markets.

 

Cheapest and most expensive Brics (lower number = cheaper market)

BRIC index Price/bookPrice/earnings
MSCI Russia0.566.82
MSCI India 2.9422.22
MSCI Brazil 0.8415.69
MSCI China 1.319.96

Source: Bloomberg, as at 7 January 2016

 

Valuation metrics for listed Russian funds

Listed Russia fundYield Price/book
db x-trackers MSCI Russia Capped Index UCITS ETF (XMRC)5.100.43
HSBC MSCI Russia Capped UCITS ETF (HRUB)5.670.45
iShares MSCI Russia ADR/GDR UCITs ETF (CRU1)5.58n/a
Lyxor UCITS ETF Russia (RUSL)6.24n/a
JPMorgan Russian Securities (JRS)4.711.28

Source: Bloomberg, as at 7 January 2016

 

India – the least risky Bric

India continues to be the bright light of the Brics, but is now far from cheap. According to Canaccord Genuity: "The growth prospects for India appear among the best in the world, although arguably this is more than priced into financial markets. The overall level of debt in the economy is low, while India is also a prime beneficiary of lower commodity prices."

India was much-hyped following the election of reformist prime minister Narendra Modi in 2014. The market soared on the back of hopes that he would open up the country to foreign investment and harness India's major potential as a global powerhouse. Although that process is proving sticky, the region remains an investor favourite and that optimism has pushed up prices.

The index is now trading on a price/earnings multiple of 22.2, far higher than Russia at 6.82 times and China at 9.96 times. It is also trading at a higher price-to-book ratio than any other Bric, at 2.94.

But Indian equities have also delivered among the best returns in recent years at a lower risk than any other Bric economy (see table below). Last year, the country's main index was less volatile than Russia, China and Brazil by far according to FE Trustnet. Over the 2015 calendar year India's maximum drawdown figure - the biggest drop between peak and trough - was far lower than its peers at 15.3 per cent. That means that if you had bought the market at the peak and sold at the worst point you would have lost 15.3 per cent, in contrast to Brazil and China where you would have lost almost 40 and 30 per cent of your investment buying high and selling low.

You would also have lost less in the worst possible scenario in 2015. MSCI India Index's maximum loss was 10.8 per cent compared with over 31 per cent for Brazil, and the downside risk - the risk of potential losses - was just 17.5 per cent compared with 19.8 per cent for Russia, over 24 per cent for China and almost 30 per cent for Brazil.

Over three years Jupiter India (GB00B4TZHH95) has returned 40.8 per cent and Neptune India (GB00B1L6DT30) has delivered almost 30 per cent, while IC Top 100 Fund New India Investment Trust (NII) and JPMorgan Indian Investment Trust (JII) have also delivered double-digit returns. Their more recent performance has not been strong, though, and India is unlikely to surge again in the way it did in 2014. Despite that, it remains a good bet.

 

Riskiest Brics (low numbers = less risk)

Riskiest markets 

Downside risk 2014-2015

Maximum drawdown 2014-15 Maximum loss 2014-15
MSCI India TR in GB17.5-15.3-10.8
MSCI Brazil 29.3-38.7-31.1
MSCI China 24.9-28.7-28.7
MSCI Russia 19.8-21.9-20.8

Source: FE Analytics, as at 8 January 2016

 

Brazil

Brazil is on very few buy lists due to intense political uncertainty and a deep recession, combined with an ongoing corruption investigation at state-owned Petrobras (PETR4:SAO). In September, Standard & Poor's downgraded the country's credit rating to junk bond status, BB+, which means the agency thinks it is less certain the country will repay its debt. President Dilma Rousseff is facing calls for impeachment.

Mr Richdale says: "Brazil continues to face political scandal, and has multiple challenges on both the economic and political front. Macro data is still deteriorating and with President Dilma Rousseff's popularity at new lows, and impeachment an increasing possibility, there has been political gridlock in terms of enacting reforms."

But he adds that Brazil's currency is very cheap, so he has been adding to positions on a valuation basis.

Mr Butterfill argues that the risks outweigh the appeal of low prices. He says: "I'm worried about Brazil. It is attractively valued and likely to experience a pop in commodities. But there are serious political issues which need to be overcome. I think we could see a rise in debt problems in Brazil, and while it's hard to say that we would see a default, it is possible."

 

Performance (cumulative total return %) of all Bric markets

Bric index 1m3m6m1yr3yr5yr10yr
MSCI Brazil -10.7-15.4-33.2-41.1-57.0-66.3-3.9
MSCI China-3.6-4.8-10.9-11.04.02.4186.9
MSCI India 1.7-5.3-9.5-5.915.8-5.8120.5
MSCI Russia -3.8-10.1-11.93.2-40.5-46.4-26.7

Source: FE Analytics, as at 8 January 2016