British investors are falling out of love with Brazil, Russia, India and China - aka - the BRICs. Over the past year alone (to 30 November 2013), they have taken out so much money from these countries that if it were lined up head-to-tail in £10 notes, it would reach twice around the world's equator.
And they certainly didn't move £5 billion for no reason. The previously solid story of rapid development - and an 'exponentially growing middle class' once made the potential for higher returns feel like a sure thing. The BRICs were the gems in the crown of emerging markets. But are they beginning to crumble under new pressures? Developed world stock markets, which looked comparatively stale, have rebounded and the BRICs now look like a scary place to have money invested.
As a result, a number of professional investors have severely reduced and in some cases completely sold out of emerging markets - including the BRICs.
One such investor is Sean Port, chief investment officer at Nutmeg, who decided to sell out of virtually all emerging market exposure in early June. The three years of emerging markets having underperformed stock markets in the developed world just doesn't cut it for Mr Port, who believes the emerging markets anaemia will continue in 2014.
He says: "On an aggregate basis, emerging market valuations look cheap, but this is concentrated in large markets, with pockets of high valuation in some countries like the Phillipines and Mexico. And there's a massive valuation gap between private sector growth and consumer stocks, versus large part state-owned enterprises, which is problematic."
Of the emerging markets, he only remains invested in Korea. However, it's debatable whether Korea is even an emerging market anymore, as it's become so advanced.
Compare total returns of open ended and investment trusts that invest in the BRICS (both individual country funds and comprehensive BRIC funds) to those investing in global equity over the past year, and you'll be bitterly disappointed if you're invested in the former.
The average total return for all the BRICS funds combined over 12 months (to 29 November 2013) is 6.24 per cent. But this looks puny compared to the meaty 21.93 per cent average total return of funds in Morningstar's global large-cap equity sector.
Which BRICS fund managers are delivering strong returns and beating their benchmarks?
| Morningstar sector | 1-year total return (average) | Average benchmark outperformance |
| Brazil Equity | -10.38 | -3.7 |
| BRIC Equity | 0.88 | -0.65 |
| China Equity | 18.39 | 7.21 |
| Greater China Equity | 13.84 | 3.07 |
| India Equity | -6.75 | -1.2 |
| Russia Equity | 5.58 | 3.23 |
| Source: Morningstar on 29 November 2013 | ||
But the blow is at least somewhat sweetened when you consider that despite a tough environment, the managers of active BRIC funds trumped the global equity funds, with a cumulative 2.74 per cent outperformance, compared to an average of -0.36 per cent.
Don't take this as evidence that all BRIC fund managers are better, though. Because there is one country that's been propping up a tired pack - and that's China. UK domiciled actively managed China funds boast an 18.39 per cent average annual return, and beat the benchmark by an average of 7.21 per cent (to 29 November 2013), according to Morningstar.
Greater China funds also performed well this year, with a 13.84 per cent average annual return which comes in at an average of 3.05 per cent above the funds' relative benchmarks.
Sadly the story has been far grimmer for the rest of the BRICs funds, and here we slice and dice exactly what's been happening in each of the nations, and which funds (if any) you should be buying.
Brazil
UK investors are pulling out of Brazil in droves. Morningstar data shows £34m in British investments was removed from the country in October alone, with more than half a billion pounds (£570m) flowing out over the last year to date (to 31 October 2013).
Actively managed pure Brazil funds lost 10.38 per cent on average over the past 12 months, lagging their benchmark indices by an average of 3.7 per cent - the biggest underperformance of any of the BRIC regions.
And it gets even worse. Not only did every actively managed Brazil fund make a loss over the past year, but they all lagged their benchmark indices as well.
However, with an upcoming election, as well as the World Cup and Olympic Games in the not so distant future, optimists believe the country could be in for a turnaround. However, they do tend to be the managers of Latin American funds, and their predictions are often wrong. In May, Will Landers, senior portfolio manager of the BlackRock Latin American Investment Trust (BRLA), said Brazil could deliver growth of up to 3 per cent for the rest of this year, and could be one of the most "attractive" equity investment opportunities. But the Brazil stock market is now lower than it was in May.
Fund picks
Investing in Brazil in the current climate is not for the faint-hearted, but if you're determined, it might be more sensible to go for a low cost exchange traded fund (ETF) or tracker fund - and one that spans the whole of Latin America, to give some diversity. Peter Sleep, ETF specialist at Seven Investment Management, likes SPDR MSCI EM Latin America ETF (GBP) (EMLA) which has a TER of 0.65 per cent, and iShares MSCI EM Latin America (IE) (GBP) (LTAM) with a TER of 0.74 per cent. He says these ETFs are both large, liquid, and relatively cheap to trade with a narrow bid offer spread of around 0.6 per cent.
Russia
Collectively, pure Russia funds have returned an average of 5.58 per cent over the past 12 months (to 29 November 2013), beating their benchmarks by 3.23 per cent average, according to Morningstar.
(It's worth noting that because commodities companies form such a huge chunk of the Russian stock market, a number of Russia funds are skewed away from the sector to give investors more balance.)
Russia is the ninth biggest consumer market for its size, according to the World Economic Forum, with over 139 million people, whose incomes are increasing every year. Only 14.4 per cent of the adult population has a credit history, though, according to the World Bank, which means its domestic consumer market is far from mature - creating a potential growth area for investors.
It's also a huge commodity hub with 32 per cent of explored world natural reserves, and 35 per cent of world gas production and exports.
Fund picks
ETFs such as the iShares MSCI Russia Capped Index Fund (ERUS) will allow you to track the Russian stock market but with less exposure to oil and gas - however, be warned, as investors have been pulling huge amounts of money from these vehicles this year. Fears of poor corporate governance is to blame.
For Russia exposure, we like BlackRock Emerging Europe (BEEP), which aims to achieve long-term capital growth by investing in companies that mainly do business in Eastern Europe, Russia, Central Asia and Turkey. It earned a place in our Top 100 Funds and changed its strategy in June, reducing the number of holdings it owns down from around 50, to between 20 and 30.
The trust says this will enable its managers (Sam Vecht and David Reid) to adopt a more conviction-based approach, and concentrate on their best investment ideas. It's currently trading on a wide 8.45 per cent discount, too, which makes it look good value.
India
In aggregate, actively managed Indian funds have had a woeful year. On average, India funds lost 6.75 per cent over the past 12 months and underperformed their benchmark by 1.2 per cent. Standard Life's CICAV Indian fund had the worst underperformance. lagging its benchmark by a whopping 15.18 per cent, with a total loss of 12.84 per cent over the period.
Caroline Keen, a manager within Newton's Asian Income Fund, says business sentiment in India is weak, and that the impending elections are causing uncertainty. She says the most attractive long-term investments are the private hospital operators and consumer companies focused on innovation with distribution capability.
Sam Mahtani, manager at F&C's Global Emerging Markets Portfolio, said the outlook for India could be improving, though. "The Indian government has released economic data showing the Indian economy is in for a shallow recovery, helped by a pick-up in exports and a stronger rural economy as heavy monsoon rains boost agricultural output," he says. "The economy grew by 4.8 per cent year on year in the three months to the end of September 2013, compared to 4.4 per cent year on year in the previous quarter."
He remains positive on the outlook for Indian stocks, too. He focuses on high-quality companies with good medium-term prospects such as ICICI Bank, HDFC Bank and Tata Consultancy Services.
Fund picks
If you want a pure India fund, First State's Indian Subcontinent fund (ISIN: GB00B1FXTF86) has been one of the only funds to make a positive total return over the last year to date (4.4 per cent), and has consistently beaten its benchmark over the last five years. Over five years (to 31 October), it has produced an impressive 162.9 per cent, compared to its benchmark's total return of 84.4 per cent over the same period. The annual management charge is 1.75 per cent.
Or if you'd rather have an Asian fund with a heavy weighting to India, Aberdeen Asset Management's Edinburgh Dragon Trust (EFM) is overweight in India with a 14 per cent allocation (versus 8 per cent in the benchmark). It's trading on a discount of 8.43 per cent and is one of our Top 100 Funds for 2013, aiming for long-term capital growth through investments in the Far East, excluding Japan & Australasia. It has a strong performance record and does not let market indices dictate how much should be held in a particular market or sector. According to Oriel Securities, it will maintain its heavy weighting in India for the foreseeable future. The manager's decision comes despite current macroeconomic headwinds, such as high fiscal and current account deficits, inflation, and continuing infrastructure bottlenecks. See our Top 100 Funds Update on Edinburgh Dragon Trust for more information.
China
UK-listed actively managed China funds produced an average total return of 18.39 over the past year to date (29 November 2013), according to Morningstar data. More encouraging still, the average fund beat its benchmark by 7.21 per cent over the same period, meaning China fund managers are still working hard to deliver good results, as well as having the odds in their favour.
And with the stock market booming, China is fast becoming a land of millionaires. Despite a global recession and regional economic volatility, Chinese millionaires held 27 per cent of the country's wealth in 2012 (US$5.2 trillion), and this figure is expected to reach US$9.4 trillion by 2017, according to Wealth Insight research.
All this accumulating wealth means China is now the world's second largest economy over the last decade, with its GDP growing by more than 8 per cent on average each year.
In spite of this rally, though, not everyone is that keen on China as an investment. For example, the managers of Edinburgh Dragon Trust have an underweight position in China-listed stocks. They are most concerned about asset quality in the banking sector, and are put off by high levels of corruption and weak corporate governance in China in general - a factor that drives a wedge between investors and the region.
Fund picks
If you're set on a Chinese fund for your portfolio, we like JP Morgan's Chinese Investment Trust (JMC), which we feel has a good pedigree of investing in Greater China companies. It's also cheaper (with a 1.41 per cent ongoing charge), is trading on a 10.05 per cent discount, and has a longer track record than Anthony Bolton's popular Fidelity China Special Situations fund (FCSS). Over one year, it's beaten its benchmark (the MSCI Golden Dragon index) with an 18.60 per cent total return, against 13.21 per cent. Over five years, it's also beaten the benchmark, but over three years it's lagged, with a loss of 5.02 percent against 7.99 per cent for the benchmark.
Also worth a look is Invesco Perpetual's Hong Kong & China fund (ISIN: GB0033028332). We tipped it earlier this year after it pipped each and every rival in the Investment Management Association's China/Greater China sector over the past year, and proved to be a top five performer over three years. And it's lived up to expectations over a year to date (to 29 November 2013), delivering a 27.95 per cent per cent return - the top performing Greater China fund on the London Stock Exchange and beating its benchmark (MSCI AC Golden Dragon NR USD) by 17.86 per cent.
