Q&A: emerging markets

23 September 2009

At the start of September, Moneywise hosted a live webchat with two investment experts - Michael Konstantinov, fund manager of Allianz RCM BRIC Stars Fund, and Darius McDermott, managing director of Chelsea Financial Services – to find out what the future holds for the emerging markets.

The BRIC countries of Brazil, Russia, India and China are steadily increasing their global economic presence. As these economies move out of the shadows, there is talk of a future where the United States no longer leads the world’s economy. But what does this mean for investors? Should they join the BRIC success story, and do the benefits of investing in emerging markets outweigh the risks?

Here are the best of your questions and the answers

Q: Which of the BRIC countries do you feel has the most opportunity at the moment and why?

Darius McDermott (DM): The first thing I would say is that the BRIC markets are among the biggest emerging markets and make up the biggest part of the emerging market universe. In general I would say the BRIC funds are slightly higher risk as general emerging market funds have more diversification.

Michael Konstantinov (MK): Brazil, Russia, India and China represent four of the largest domestic economies and therefore have been less affected by the global economic slowdown and have already started to recover. Therefore an investment in BRIC is an investment in the highest growth areas in emerging markets.

Q: I want to know more on the different strategies an investor could use to invest in the emerging markets.

DM: Emerging markets have doubled over approximately the last 10 years as a percentage of the world market. This leads me to believe that people should be investing approximately double the allocation they would have previously given. Another key point is BRIC markets can be quite volatile and a sensible way of investing is via monthly savings, which give you ‘pound cost averaging’.

Q: Could you discuss some ways of investing in the BRICs - are ETFs the best way or why would actively managed funds be better?

DM: The best actively managed funds will tend to outperform the underlying index and hence the ETF, and as long as you are investing with a premium manager it is worth paying the extra charges.

MK: The fast development in the BRIC markets results in many new company listings and as an active manager we can take advantage of new investment opportunities, which tend not to be reflected in the ETFs.

Q: Today many people fear what could happen when eventually governmental support will be cut off. The recent rapid recovery on the stockmarkets could just be a bubble. But how is the situation in the emerging countries? Is the recovery based on governmental support or is there a good foundation for the rapid recovery? If a double dip recession follows, will they be able to resist?

MK: China today sells more cars than the US. This is one example of how important domestic demand in the BRIC economies has already become. This dynamic has helped the BRIC economies to come out of this global slowdown faster than the US or Europe and is providing an important foundation for future growth. Therefore, I believe that the growth outlook will be very positive even if the developed markets continue to suffer.

DM: I believe that globally - not just in emerging markets - that government stimulus packages have helped markets recover. The BRIC markets have risen more than mature (i.e. Western) markets and the sharp rise in these markets should be noted.

Q: Can I put BRIC funds within an ISA or other tax efficient wrapper?

DM: Yes - BRIC funds absolutely qualify for ISA investments.

Q: If everyone piles into emerging markets, how can more rational investors make sensible long-term choices?

DM: The key to this is the length of time people want to invest – if you are looking to make a quick profit in the next six months, the sharp rise in BRIC markets should be taken into account. That said, I think now is an excellent entry point for long-term investors (i.e. a minimum of five years) to invest in high growth markets like the BRIC markets.

MK: BRIC markets represent 40% of the world population with a growing affluence. The new consumer class will become the new driver of the world economy. It is expected the BRIC markets will be among the five largest economies in the world and therefore a BRIC investment can participate in this long-term growth.

Q: Given that the tracker I had in India fell something like 10% in one morning during the credit crunch I am somewhat sceptical about further investing in emerging economies. How should I balance the risk here?

DM: Investing in the BRIC markets, for me, is some of the riskiest areas you can invest in. You need to be aware that there could be currency, geopolitical, and corporate governance risks and hence investment in BRIC is not suitable for those with lower risk 'tolerances'. On the other hand, of course, the higher risk in this area could potentially lead to much higher returns.

MK: The recent sell-off was initiated by the financial crisis in the US. The encouraging thing is that BRIC economies and equity markets have started to recover quickly because the negative impact has been not as strong as expected. I believe that you should find there is less volatility in the coming years.

Q: Does a weak economy in the West lead to more trade or less trade with BRIC countries?

MK: I think that recent trends show that trade within the BRIC countries is increasingly important - and starting to replace part of the lost trade with Western countries. Over time this should lead to less dependence on the West.

Q: The emerging markets have gone up very fast in the last few months. Is this growth justified or is a bubble being created around emerging markets? Is a correction going to take place? Will these markets know more growth in the second half of the year?

DM: The BRIC markets have the strongest GDP growths particularly compared to the more mature Western markets. GDP forecasts of 8.8% for China and 7.2% for India in 2010 are way in excess of growth rates expected in Western economies.

Referring to my earlier answer – the fact that the markets have risen so sharply since March - does need taking into account depending on your investment time horizon. Another factor in the strong rise since March was the fact that these markets were heavily oversold in the previous 12 months.

MK: If you look at current variations in the BRIC markets, they are in the middle of the historical valuation range with an expected earnings growth of 20% to 25% for next year. I believe a BRIC investment still offers attractive rewards.

Q: What do you think about separate country funds vs. a combined one?

DM: Separate country funds are a higher risk than a BRIC fund because with these you get greater diversification with the four markets. China has the strongest forecast GDP growth. Russia is the cheapest on valuations. India is going to have the biggest population growth and thus the greatest proportion of middle-class consumers. Brazil will supply a lot of the materials for the growth in those other countries.

There will be periods of time where a single country fund will out-perform a BRIC fund but investing long-term in BRIC funds offers a simple way of getting access to all these high-growth markets.

Q: Can we still include Russia in the BRICs? And, will Russia recover as fast as the others?

MK: I am a clear believer in the ‘commodities supercycle’, which is a result of the limited commodity supply and the commodity intensive industrialisation of the BRIC markets. For instance, the BRIC countries are demanding more energy, copper, oil, iron ore etc. This strong demand for commodities will result in higher commodity prices for longer and one of the prime beneficiaries of this trend will be Russia, because Russia is the second largest oil producer in the world. As the Russian equity market is strongly correlated to commodity and energy prices, the prospect is closely related to the BRIC story.

Q: To what extent are the BRIC markets vulnerable to political instability? They all seem to have fragilities in one way or another. Is this something I need to worry about?

MK: These concerns contribute to the fact that, yes, these are high-risk investments. If you are uncomfortable about the risk then you should perhaps not invest in these areas.

Q: Am I damaging the economy in the UK by investing my money elsewhere?

DM: It's a good question and I would answer by saying that the biggest 100 UK companies - the FTSE 100 - generate 60% of their earnings overseas so I do not feel that investing overseas is damaging to the UK.

Q: How do you see BRIC markets evolving in the next five years?

MK: I am expecting similar growth rates for the BRIC markets to the ones we have seen in the previous years. This growth path is driven by the growing affluence of the middle classes and will be driving the earnings growth of the BRIC countries’ listed companies. On the back of that I expect markets to appreciate in accordance with 20% annual earnings growth

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