Diversifying Investments into BRIC / Emerging Economies: Pros and Cons

GUEST ARTICLE: Investors are often told to diversify instead of keeping their money only in Australian assets.

Tim Hewson from Raboplus weighs the pros and cons of investment diversification overseas – considering that BRIC (Brazil, Russia, India and China) stock markets are likely to be quite volatile and the S&P 500 is almost the same value now as it was 9-10 years ago.

In April earlier this year, the International Monetary Fund (IMF) forecast that emerging markets will continue to grow at between 6% – 7% and up to 4% above developed economies.

In basic terms, the economic fundamentals of the emerging market economies are stronger than developed economies and they currently account for up to 75% of global growth.

Emerging economies typically maintain high foreign reserves, have high current account surpluses and are reducing their foreign debt levels, have low levels of household debt, continue to experience real growth despite high inflation levels and have reduced their historical reliance upon trading partners like the US.

Most importantly, emerging market economies like China have recently focused inwards and are beginning to sustain their own growth due to rapid industrialisation and urbanisation and are relying less upon traditional export growth as a result.

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According to Russell Investment Group, BRIC (Brazil, Russia, India and China) all continue to show potential for investors to enhance their long-term returns by up to 1.5% – 2% pa with both China and India still generating double digit growth. However, the important carve-out here is that such significant growth obviously comes at the cost of higher volatility.

And although you would normally expect that global diversification to reduce risk, the BRIC nations continue to remain more volatile than developed economies. As an example, the Chinese and Indian markets are down by an estimated 34% and 20% respectively and are still regarded as being expensive.

On a more positive note, there is the opportunity to partially mitigate volatility as the AUD maintains a reasonable degree of currency correlation with emerging market currencies. So as one of their closest resources and commodity trading partners, Australia is by default inextricably entwined to the emerging market growth story.

Beware, things are beginning to slow.

The first quarter of 2008 showed distinct signs of slowing amongst the BRIC nations and many investors received negative AUD performance for the March 2008 quarter as investor appetite for risk begins to show signs of diminishing.

China is also facing several challenges with increasing inflation and the challenge of appropriate monetary policy settings. And whilst inflation remains a major concern, how the single party socialist republic state ruled by a communist party deals with inflation will be very closely monitored.

Linking the monetary policy of emerging markets to that of the US could be one way of dealing with this issue, but it is largely impractical with what appears to be increasing support for the decoupling of the emerging and developed economies.

It’s fair to say that the emerging markets have also become addicted to undervalued currencies in order to improve their exports. With cheap currencies no longer the case, trading partners now the recipients of exported inflation from the region.

It would also appear that all BRIC nations face several micro-economic challenges in the coming years.

Of note is Brazil’s public sector debt which accounts for 50% of GDP, Russia’s increasing lack of transparency and embedded corruption, India’s lack of infrastructure and China’s ‘one-child’ policy likely to hamper future growth trends.

In contrast, investors face the competing issues of the need to diversify, the potential for future growth from emerging economies and the fact that the region is likely to remain largely immune from a looming US recession.

But, it’s also worth considering the impact of currency volatility, the differences in tax treatment when investing in these nations and the difficulty in making country specific allocations against the backdrop of rapidly changing economic environments.

Needless to say, there are likely to be some significant investment opportunities for the emerging economies in the years to come as the Asian tigers continue their prowl.

Tim Hewson

This article was written by Tim Hewson, Senior Manager – Investments and Managed Funds, International Direct Banking at Raboplus

Tim has more than 12 years experience working in banking and financial services including Raboplus, specialist boutique investment firm Absolute Capital Limited and the Commonwealth Bank of Australia.

You can read more articles by Tim at his own blog, Confident Investor where he discusses topical financial issues and at the Raboplus Investor Centre where Tim writes a monthly hot tips column giving his opinion and commentary about investing and what’s happening in the market.

If you’re a blogger or an expert about a topic I cover on this blog I encourage you to contact me and I’ll consider publishing your guest article here including generous attribution and back links back to your website as thanks for your contribution

5 thoughts on “Diversifying Investments into BRIC / Emerging Economies: Pros and Cons”

  1. Investing in emerging markets depends on the amount of risk that can be tolerated. Though statistically the author seems very convincing, u can never estimate how the markets of these emerging economies bounce back and rightly said Asian tigers will continue to grow. Beware as Chindia will definitely emerge stronger than expected within a few years.

  2. I have a hard time with the idea china can still grow close to the rate they have with just thier own growth or very little growth from the US.

    The SP500 right now is agreat time to buy anything that produces cash with a dividend. You get paid to wait and when the stock comes back you make good money.

  3. Investments in emerging markets are always risky. Brazil seems to be attractive at the moment, and Vietnam is also worth a look.

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