Millions of dollars are making their way to mutual funds and exchange-traded funds focused on the developing world's new powerhouses -- China, India and Brazil. The returns have been awesome, until very recently. Now they are plummeting. Should you hold these kinds of investments now?
First, it's important to understand that formidable political, economic and demographic factors are contributing to the strength and investment attractiveness of these countries.
Brazil, a country with 186 million people, has a relatively young population. Twenty-six percent of its nationals are under the age of 14. It also boasts a diverse and robust economy. There will be an estimated 260 million Brazilians by the year 2050. Demographically, then, more and more Brazilians will continue to move into peak investing years, turbocharging consumer spending and boosting the demand for local equities. It's a good place to invest.
The annualized return of Brazil's Bovespa stock index was 19.5% on average each year over the last five years. And the Brazilian stock market is trading with a P/E ratio of only 11.8 -- better than the
P/E ratio at the close of 2005.
China now has the world's largest population -- 1.3 billion people, with 22% under the age of 14. It produced a cumulative stock return of 65% over the past five years and a 15.4% return in 2005. It is a market that is attracting a huge amount of attention.
India will have the world's largest population in 2050, adding
new people to its current 1.1 billion headcount over the next 20 years alone. Its stocks delivered a 200% cumulative return over the past five years -- 33.3% in 2005 alone. And with many millions of Indian consumers increasingly buying goods and services, Indian equities should have an exceptionally bright future.
These three countries have moved from erratic economic growth and political storms to sustained growth and general stability. India's economy is growing by 7.1% per annum and China's by 9.2% (at least according to official statistics.) All three countries have legal systems that are doing quite a good job bringing discipline to business growth and investment. Not surprisingly, investors worldwide are plowing huge amounts of capital into the stocks of all three countries.
That is, they
been plowing capital into these countries; in recent weeks and months, investors have been heading for the exits. With that in mind, let's take a look at some of the funds focused on these markets.
iShares MSCI Brazil Index
delivered a hefty 52.7% return in 2005. The trailing one-year return has been in the range of 70% -- but this very good ETF has been dropping in price for the last two weeks and was down another 6.2% Monday. There are also a number of regional funds -- such as the excellent
Fidelity Latin America fund -- that have extensive Brazilian exposure and once delivered exceptional returns as well. The Fidelity Latin America fund, for instance, returned 55.2% in 2005 and gave investors broader diversification. But that fund is also coming down hard in recent weeks and Brazil's Bovespa fell another 3% Monday.
You can invest in Chinese equities via a number of exchange-traded, as well as, mutual funds. I happen to like the
iShares FTSE/Xinhua China Index
. However, it has begun to plummet as well recently and was down another 6.6% Monday. The
Dreyfus Premier Greater China and
AllianceBernstein Great China '97 are also very good funds with a China focus. And they, too, have begun to tumble.
On the India front, the Morgan Stanley India Investment fund
once delivered top results. It posted a three-year average return of over 74%, but is down 13.5% in recent days and another 9% Monday.
Eaton Vance's Great India A fund delivered 45.1% in 2005, but is down about 8.5% for the past week; on Monday, Bombay's BSE Index fell 4.2% after being down more than 10% intraday.
On one hand, the 2005 returns for these kinds of funds were blockbuster. And that caused even more investors to buy in. On the other hand, the recent declines are not minor "downdrafts." They probably herald the burn-off of some of the substantial speculative excess in emerging-market funds.
High returns come with high risks, and the risks of investing in emerging markets are extremely high. When you invest in a single-country emerging-market fund, you are narrowly concentrating your investment in a limited number of stocks in a generally high-risk, often less-efficient market. Such funds are subject to foreign-exchange turmoil and performance whiplash. And even after their very recent declines, funds focused on Brazil, India and China still contain a large amount of speculative markup.
Should you buy in? I strongly recommend against it. The stock markets of these countries are absolutely overheated. You'll be coming late to the party. And if you currently own these kinds of investments, this may be a good time to sell your positions, take profits and wait for prices to simmer down even more.
Recommendation No. 1: Preserve your profits and reduce your emerging-market positions
Recommendation No. 2: When you do move back into emerging-market investments, consider funds having a broader international mandate, instead of a single-country focus. Let professional investment managers judge the very different emerging markets for you. And let them decide when to hold Chinese, Brazilian or any other specific market's equities.
Some excellent funds that will give you this kind of exposure are the
Julius Baer International II A fund and the
Vanguard Total International Stock Index, an index fund I happen to hold that gives you some 10% to 15% exposure in emerging-market stocks and the balance in Pacific and European equities.
Now is a time to be leery of country-specific China, Brazil and India funds. If you buy them today, you'll still be buying speculative froth. If you own them, take your profits and move to broader exposure. Investments in the equities of Brazil, China and India have outstanding long-term prospects, but buying in right now is simply not advisable.
As originally published, this story contained an error. Please see
Corrections and Clarifications.
Jim Schlagheck is a wealth management professional who has counseled ultra-high-net-worth families, endowments and pension funds in the U.S., Europe, and the Middle East. He is a former senior executive of American Express Bank, UBS AG, Bank Julius Baer, and TAIB Bank. During his career, Schlagheck launched a family of mutual funds (now holding $4 billion), led teams of financial planners and investment advisers based in New York, Bahrain, and Geneva, Switzerland, and helped many high-profile clients to protect and enlarge their wealth. Jim has a blog on investment topics
www.invest-blog.com and is the author of "Show Me The Money!", a soon-to-be-published book that synthesizes his novel views about investing for retirement.