Profit From the Fantastic Four

In 2001, the clever folks at Goldman Sachs coined a new acronym: BRIC. BRIC stands for Brazil, Russia, India, China -- the four colossi of the developing world. BRIC is a marketing slogan, but it's one that captures the imagination and simplifies the investment story in emerging markets.

As if on cue, the BRIC economies have gone from strength to strength this decade. Their stock markets have dazzled. The four giants now represent 45% of the entire market value of the MSCI Emerging Markets index.

Over the past five years, the four countries have generated the bulk of world economic growth. Goldman Sachs projects that the BRICs, collectively, will surpass the scale of the U.S. economy sometime around 2025. From energy to metals and grains, growth in the BRICs is driving global commodity markets.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

The four countries are, of course, utterly different in terms of geography, culture, strengths and weaknesses. But from an investor's perspective, there is logic in addressing them together. For instance, Russia and Brazil are both massive exporters of natural resources, and together they complement China and India, two enormous net importers of commodities.

Moreover, emerging markets, as symbolized by the BRICs, are where the growth will be over the next decade. For instance, while glutted Americans are drowning in consumer debt, consumers in the four BRIC nations have borrowed relatively little. Rapidly expanding middle classes, strengthening currencies and rising consumer banking ensure that it's still morning for BRIC consumers.

Get set for a tour of the four BRIC members. We'll point out some of their economic strengths and weaknesses and identify investment opportunities.

More than Samba

Brazil is hot. It's easy to forget that this nation suffered from hyperinflation in the 1990s and seemed on the brink of defaulting on its debt earlier this decade. Now, foreign direct investment pours in and the stock market and currency have handsomely rewarded foreign investors. On April 30, Standard & Poor's bestowed an investment-grade rating on Brazil's foreign debt.

The country now benefits from a virtuous cycle. The government's skilled management of fiscal and monetary policy broke the back of inflation and restored confidence in the nation's currency, the real. Budget deficits have given way to surpluses. Interest rates have responded, tumbling from 27% in October 2003 to 11% today. Investment and consumer spending are robust.

Booming exports are generating large trade surpluses. Sun- and water-kissed Brazil has become an agribusiness giant, exporting a cornucopia of soybeans, sugar, coffee, orange juice, beef and chicken to a hungry world. The country is a major exporter of iron ore and other minerals, and, after some major recent offshore-oil discoveries, it seems the lucky country is rich in hydrocarbon reserves, too. "Brazil is firing on all cylinders," says Thomas Melendez, who manages MFS International Diversification fund.

Brazil scores well among the BRICs because it combines solid economic leadership with strong management and governance at the corporate level. Seasoned emerging-markets portfolio managers, such as Mark Gordon-James, of Aberdeen Emerging Markets, rank Brazil behind India but well ahead of China and Russia in terms of the number of attractive companies available for investment.

For instance, Vale (symbol RIO), a mining company, earns high marks for quality management. Steel companies around the globe snap up its iron ore. A series of offshore-oil finds has made Petrobras (PBR) one of the few major integrated oil companies with bright prospects for volume growth.

Brazil is rapidly becoming a middle-class country, so many of the best investment opportunities are in companies that cater to the domestic population of nearly 200 million. Brazilians historically haven't borrowed much, but lending is surging for mortgages, automobiles and other consumer goodies. Jeff Urbina, co-manager of William Blair Emerging Markets Growth, thinks highly of Banco Itau (ITU) for its operational prowess.

Indeed, emerging-markets fund managers, such as David Semple, of Van Eck Emerging Markets, see better value in smaller companies that concentrate on domestic business and are less tied to the global commodity cycle. The best way to gain entry into the domestic economy is through a diversified fund.

[page break]

T. Rowe Price Latin America (PRLAX) has a fine long-term record, and nearly 70% of its portfolio is in Brazilian stocks. London-based manager Gonzalo Pangaro says he's focusing on Brazilian consumers by investing in department-store chains, credit-card processors and real estate companies. He likes financials such as Itau and Banco Bradesco (BBD), which are expanding their loan books 20% to 25% a year. One of his favorite exporters is Perdigao (PDA), a big poultry producer.

If you prefer investing through low-cost, unmanaged exchange-traded funds, you can buy Brazil through iShares MSCI Brazil Index (EWZ).

The Russian bear awakens

Economic progress in Brazil is impressive, but Russia may win the award for most dramatic turnaround. Consider this: A decade ago, in 1998, the Russian economy collapsed. The stock market and ruble tanked, and the Russian government defaulted on both foreign and domestic debt.

Flash forward to today. Russia is running trade and budget surpluses; the country's foreign-exchange reserves have multiplied 25-fold this decade, to $500 billion, third-largest in the world. The ruble is steadily gaining in value against the dollar, and the size of the Russian economy (in U.S. dollars) has mushroomed sevenfold since 1998. The entire country is like a boomtown, says John Connor, whose Third Millennium Russia fund has returned an annualized 34% since its inception in October 1998.

As the world's largest exporter of natural resources, Russia is riding the bull run in commodities. The vast land is blessed with huge reserves of oil and gas, nickel, platinum, and titanium.

But the government of prime minister Vladimir Putin deserves much of the credit for managing the windfall adroitly. Its fiscal and monetary policies have been prudent, and the government has kept inflation in check. It's investing surpluses from commodities in infrastructure, health care, housing and education. Confidence in the currency has encouraged Russians to put their savings into rubles and to return to the banking system.

This will mark the ninth consecutive year of rapid economic growth. Russians' incomes are surging more than 20% annually, the wealth is being widely distributed, and the middle class is burgeoning. No wonder Putin -- reviled abroad for limiting the freedom of his country's press and trampling on other rights common in democracies -- is so popular at home.

London-based Julian Mayo has invested in Russia since 1996 and also likes what he sees. In fact, Mayo, who co-manages two emerging-markets funds for U.S. Global, says Russia is currently his favorite market among the BRICs. He likes the inflation hedge that Russian commodity producers provide. And he's also attracted to the surge in domestic demand for consumer goods and low levels of consumer and government indebtedness.

You can invest in Russia through Third Millennium, but the fund charges a sales fee. If you want to keep costs down, try the closed-end fund Templeton Russia and East European (TRF), managed by Mark Mobius, or the ETF Market Vectors Russia (RSX). Mobius, who says Russia is becoming a safer place to invest, is finding stocks that tap into local-consumer spending, such as supermarket chains and fruit-juice makers. In mid June, Templeton Russia traded at a 3% discount to the value of its assets.

A number of major Russian companies trade in the U.S. as American depositary receipts. One reason Mayo likes Gazprom (OGZPY.PK), the world's largest natural-gas producer and exporter, is that it stands to earn more as subsidized domestic gas prices rise toward world market prices. Gordon-James, co-manager of Aberdeen Emerging Markets, thinks oil giant Lukoil (LUKOY.PK) is still cheap by international standards when measured on a basis of share price to energy reserves and considering how much the company can improve its operational efficiency. And when you invest in Gazprom and Lukoil, says Van Eck's Semple, you know you're on the right side of the Kremlin. "The government has a clear political agenda to create national champions in energy."

Solid companies

Viewed from the top down, the Indian picture is the least attractive among the BRICs. The Indian government runs large budget deficits, driving up interest rates and starving the private sector of capital. Moreover, rising prices for energy and food are exacerbating the deficits because the government subsidizes these commodities. The inefficient government has been too slow to build infrastructure, one of the main reasons that China bounded ahead of India in export-oriented manufacturing and the ability to attract massive foreign investment in factories.

The bottom-up view, however, is more sanguine. Among the four BRIC nations, India takes the prize for corporate and management quality. Aberdeen's Gordon-James says Indian managers tend to be savvy cost-cutters who focus on core businesses and high profitability. Corporate governance is generally sound, the century-old stock exchange is broad and deep (with more than 5,000 public companies), and the country has a long tradition of local shareholder ownership.

So it's hard not to be optimistic about this young, populous nation over the long term. One industry where India is already a leader is computer software. Companies such as Infosys Technologies (INFY) and Satyam Computer Services (SAY) are competitive exporters of information-technology services.

[page break]

As wealth spreads, the middle class expands. Ranga Nathan, of Indus Advisors, a stock-index provider, puts the size of the Indian middle class at 250 million to 300 million, and he predicts that it will grow to 400 million to 500 million by 2020. Nathan says a high percentage of the population is between the ages of 20 and 40, a sweet spot for both production and consumption. "The whole aspiration curve in India is enormous," says Nathan.

The best way to tap into rising household incomes in India is through a mutual fund. Andrew Foster, of no-load Matthews India (MINDX), says he's finding some of the best growth prospects in midsize companies that were formerly local in scope but are now going national. One of his favorite holdings is Dabur, a leading maker of fruit juices, biscuits and food supplements. He also likes HDFC Bank (HDB) for its focus on credit quality in its corporate and consumer lending.

You can also access India's broad economy through two fine closed-end funds, both of which date from 1994 and sell at discounts to net asset value (NAV). Blackstone's Punita Kumar-Sinha manages India Fund (IFN) from Boston. She's convinced that long-term investors will do better in India than in the U.S. because of India's rapid wealth creation, rising consumption and attractive demographics. Under Kumar-Sinha, India Fund returned an annualized 23% on its assets over the past ten years to June 2. In mid June, it traded at a 5% discount to NAV.

Morgan Stanley India Investment (IIF), the other closed-end fund, is run by Morgan Stanley's Global Emerging Markets Equity Team. The fund recently traded at a 5% discount to NAV. If you prefer an indexed approach, consider PowerShares India Portfolio (PIN), which tracks the top 50 stocks on the Indian exchanges.

The driving force

You couldn't spell BRIC without China. The country's fast-motion industrialization, urbanization and infrastructure construction are driving the global economy.

Theresa Gusman manages DWS Global Commodities. One of her favorite strategies in running the fund is to invest in companies that produce the stuff China needs: commodities such as oil, copper, iron ore, coking coal and aluminum. When you combine China's massive population with its frenetic economic growth rate, you have an equation that can roil world markets -- and provide some excellent investment opportunities.

But investing directly in China isn't as easy as you may think. William Blair's Urbina says that from a big-picture perspective, China is more attractive than India. But on the individual-company level, China is wanting.

Recall that the modern Chinese economy and its stock exchanges are recent phenomena. Chinese companies don't have much experience managing through hard times, and the challenges are growing. Inflation has spiked this year and wages are rising rapidly on the coast. The Chinese currency is steadily appreciating. The government has suppressed domestic energy prices (Chinese are paying less than half the world price for oil), which is an unsustainable policy.

So as in India, you're probably best off with a fund manager who knows the lay of the land and can deliver a diversified, dynamic portfolio. One such manager is Richard Gao, of no-load Matthews China (MCHFX), which has returned 17% annualized over the past decade. Gao says he's reduced the fund's exposure to exports because of rising domestic costs and a weak U.S. economy.

Instead, Gao is focusing on the Chinese consumer. "Domestic consumption will become the driving force for China's economy going forward," he says. Growth premised on the rapidly expanding urban population is more consistent and sustainable than depending on export markets.

Gao notes that retail sales are expanding by 20% a year in China. He likes the intersection of technology and consumption. Two of his favorite stocks are China Mobile (CHL), the world's largest cell-phone operator, and Sina (SINA), the nation's leading Internet portal -- the "Yahoo of China."

You can also invest in China through an open-end fund, Fidelity China Region (FHKCX), and through China Fund (CHN), a closed-end fund with an impressive long-term record (a return on its assets of 22% annualized over ten years). It recently sold for a 12% discount to NAV. Indexers can gain entry to the Middle Kingdom via iShares FTSE/Xinhua China 25 (FXI), which holds 25 of the nation's largest, most liquid companies.

All BRICs all the time

Finally, if you prefer the less volatile path of investing simultaneously in all four BRICs, you can do so through two ETFs. The Claymore/BNY BRIC ETF (EEB) is heavily concentrated in Brazilian and Chinese stocks. The iShares MSCI BRIC Index (BKF) ETF is more evenly balanced among the four BRIC nations.