No new BRICS, say experts

By Scot Blythe | May 16, 2013 | Last updated on May 16, 2013
2 min read

It’s been 25 years since MSCI launched its Emerging Markets index. And those markets now make up 12% of the MSCI All Countries World Index. But don’t expect another BRIC breakthrough.

Read: BRICS to build rival bank to IMF

Still, there could soon be a modest reweighting of the emerging markets component of the MSCI ACWI, Juliana Bambaci, a senior associate with MSCI’s applied index research group told IMN’s 12th annual Canada Cup of Investment Management conference in Toronto.

The boost would come from China. The country’s shares come in a variety of classes and currencies and trade on different exchanges. Approximately 55% of China’s market capitalization consists of A shares that are only available to citizens.

As China’s government liberalizes its economy, those shares may become open to foreigners. That would double China’s weight in the MSCI EM to 25%, and in the MSCI ACWI to 4%, Bambaci says.

Regardless, the MSCI EM is heavily weighted to seven of 21 constituents: BRICS plus Taiwan and Korea, notes Kemal Ahmed, a portfolio manager at Investec Asset Management.

That means there is significant tracking error for ETFs investing in emerging markets, because it’s harder to access smaller country markets. This is less of a problem with actively managed EM funds, because the full opportunity set does not need to be deployed.

Outside the Big Seven, the remaining 23% includes Poland, Chile and Indonesia, which he calls horizon markets. The index also includes frontier markets (which can also be accessed through a separate MSCI index): the Persian Gulf petro states, Nigeria and Argentina.

Read: Vik’s Pick: Investors misguided about Russia

Including horizon markets dampens emerging market volatility because liquidity is lacking. The prime investors are domestic funds, such as pension funds and insurance companies.

But there are limits to the emerging market growth story, suggests Alan Ayres, emerging markets senior product manager at Schroder Investment Management. In the past decade, these economies expanded not just at a rapid pace, but also exponentially. As a consequence, the emerging market share of global GDP grew from 25% to 40%.

Will that pace continue?

“Profits follow the economy quite closely,” he notes. But last year, profits remained steady. So, the emerging market “step change was probably a one-off.” Nevertheless, emerging market valuations are still attractive.

Emerging market debt

Tristan Sones, vice-president and portfolio manager at AGF Investments Inc. says emerging market debt “is really here to stay as an asset class.”

Just more than a decade ago, emerging market debt consisted of sovereign bonds denominated in U.S. dollars. That was problematic since there was a mismatch between the liability and revenue currencies.

Outside of frontier markets, emerging economies have increasingly issued sovereign debt in local currencies, which has stabilized the bond market, and yet local currency bonds pay out on average 5%.

Finally, corporate bonds have also come to the fore, and it’s largely investment grade — although investable emerging market debt outstanding is now bigger than U.S. high-yield market.

Read: Emerging markets fall out of love with euro

Scot Blythe