Ways to access Bric growth

Bric funds have attracted strong investor flows over time and their popularity has led to a multitude of methods to gain exposure to these markets, according to Allan Conway, head of emerging market equities for Schroders.

In addition to the more traditional method of investing via active managers, Mr Conway says investors can also invest in passive vehicles such as exchange-traded funds.

He also argues investors can increasingly gain exposure to Bric countries through an investment in many developed markets, as corporates in many developed economies are generating an increasing proportion of their revenue from the emerging world.

However, Mr Conway stresses investors should be wary of the potential limitations of some of these alternative approaches to active fund management.

“How efficient equity markets are is debatable, but it is probably fair to say that Brics are much less efficient than developed markets. Thus, there are more alpha generating opportunities in Brics making active fund management potentially a much more appropriate approach for investing in these markets.

“ETFs usually try to replicate the index by using a stock optimisation (physical ETF) approach or swaps (synthetic ETFs). Synthetic ETFs involve counterparty risk and physical ETFs tend not to achieve full replication, consequently their record of tracking Brics can be poor.

“For example, one of the largest Bric ETFs underperformed the MSCI Bric index by 281 bps in 2012, with a tracking error of 2.7 per cent [Source: Morningstar].

“Moreover, ETFs often have higher hidden costs. ETFs are likely to have high turnover due to frequent rebalancing and the costs of trading in Brics, both explicit and implicit costs, tend to be relatively high.”

He continues that by investing in a passive product investors are also potentially foregoing the opportunity of capturing pricing anomalies and potentially locking themselves into “momentum investing”.

“The stronger a company’s relative stock price the greater it’s weight in the index becomes and the more a passive fund will have to buy.”

In terms of investing in Brics via developed market stocks, this apparently also has its drawbacks.

“Such an approach means investors are still investing in companies with generally 50 per cent or more of their income from developed markets, which not only dilutes the investment but investors may also pay a premium for developed companies’ operations in the rest of the world.

“The weakness of this implicit approach is reflected in performance returns. Goldman Sachs has produced a Brics Nifty 50 Developed Markets index, which comprises 50 companies from the developed markets that are believed to directly benefit from strong growth in the emerging markets and, in particular, the Bric economies.

“However, as highlighted below, the Brics Nifty 50 Developed markets index has historically closely tracked the S&P (and underperformed the MSCI Bric index). [Source: Bloomberg. Data to 30 June 2013]”