BRIC-Headed? Or Brilliant?

June 08, 2006

Correction: TWO BRIC indexes launch, and one ETF is already on the way.

[Editor's note: The previous article in this space suggested that Dow Jones was the first company to launch a U.S. BRIC index. MSCI has hosted a BRIC index for some time, however, and the Bank of New York debuted a BRIC ADR index on June 6. Story amended to reflect these and other changes.]

It was inevitable. With all the discussion of the "BRIC" countries - meaning Brazil, Russia, India and China - you knew that, sooner or later, index- and ETF-designers were going to jump on the BRIC-branding bandwagon.  As a flurry of announcements in the past ten days shows, they've done just that.

First, Franklin Templeton Investments announced plans in late May to launch the first BRIC fund available in the United States.  The new fund will charge investors a whopping 2.15 percent in annual expenses, not to mention a 5.25 percent load.  The actively managed fund will join 18 BRIC funds already operating in Europe and Asia.  In fact, a European-version of the Franklin Templeton fund launched in October of last year: Since then, the fund has lagged its benchmark, the MSCI BRIC Index, by more than 9 percent.  I'm betting that that performance, combined with a 7.4 percent maximum first year expense ratio, will put it out of reach for most sensible index-based investors. 

More promising is the recently filed Claymore Advisers exchange-traded fund (ETF), based on the recently launchd Bank of New York BRIC Select ADR Index.  The Bank of New York (BONY) launched their BRIC index on June 5, and Claymore had filed with the Securities and Exchange Commission (SEC) for the right to launch an ETF back in late May.  The new index (and ETF) tracks the performance of all U.S.-listed ADRs from the four countries, and is a sub-index of BONY's broader ADR Index.  The ETF is one of five ETFs filed by Claymore (story forthcoming).  No expense ratio is given in the prospectus.

I don't think it will be long, either, before we see an ETF tied to the most recently launched BRIC index - the Dow Jones BRIC 50 Index.  The index is free-float-capitalization-weighted index of the 50 largest companies in these four countries. The index includes 15 companies each from Brazil, India and China, and 5 companies from Russia.

Note that the small number of Russian names does not mean that Russia is underweighted in the index - in fact, it currently has the largest allocation.  Russia only gets 5 stocks because those five stocks are enormous, largely made up of former state-run energy companies, like Gazprom.

The Chinese exposure is drawn from offshore Chinese stocks: domestic listings and "red chip" Hong Kong shares need not apply.  That fact skews the index a bit, as it cuts out some of China's largest companies. In fact, based on figures as of May 31, China had the smallest weight in the index (17 percent) despite the fact that it had the largest share of total GDP (57 percent).  In fact, the weight-versus-GDP trade-off is almost perfectly inverse for all four countries!

Country

Weight In Index

Share of GDP

Russia

34%

10%

Brazil

25%

10%

India

23%

21%

China

17%

57%

Source: Dow Jones Indexes.  Data as of 5/31/06.

GDP Comparison

Country

GDP

Percentage of Whole

China

$8.859 trillion

57%

India

$3.316 trillion

21%

Russia

$1.589 trillion

10%

Brazil

$1.556 trillion

10%

Source: CIA Factbook. Data as of 2005.

Performance

That inverse relationship is driven in part by the fact that Russia's exposure is dominated by energy companies, which have been soaring in recent years.  That, combined with the general bull market in emerging markets, has driven the index to unprecedented performance. Through the end of May, the index was up 23.1 percent.  It has returned 83.9 percent over the past twelve months, and an annualized 51.6 percent over the past three years.

Not A Sensible Asset Calss 

in my March 13 feature article, "In My Dreams…," where I played the imaginary role of ETF designer, I called for the development of a BRIC ETF. 

"Brazil, Russia, India and China may not have anything to do with one another," I wrote.  "And a BRIC ETF would only be a marketing tool, not a sensible way to allocate capital - but an ETF tracking the four horsemen of the developing world would be an instant hit with investors."

I continue to think that's true - all of it.  A BRIC ETF or mutual fund will be a huge hit with investors.  And a BRIC ETF is simply a marketing tool, not a sensible way to allocate capital.  Consider what Lars Hamich, managing director of STOXX Ltd., the joint venture which is responsible for Dow Jones Indexes' business development in Europe, Asia and the Middle East, had to say about the index:

"With the Dow Jones BRIC 50 Index, we are now able to provide investors for the first time with a blue-chip index for the most sought after emerging markets."

He's right: These are the "most sought after emerging markets."  Investors want exposure to them because they are in the headlines. The truth is that the recent strong performance in emerging markets extends is not limited to these four names, and really, these names have nothing much in common.  Nonetheless, these are the countries that you read about when you read about the rapid growth of the developing world, and investors want to be exposed to that excitement.  At least with the ETFs, they should be able to get that exposure at relatively reasonable cost.

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