BRIC

BRIC stands for Brazil - Russia - India - China. BRIC ETFs are funds designed so that in a single trade an investor can acquire relevant and representative exposure to markets in these four countries.

There are several BRIC ETFs available on the market. Though these funds have somewhat different holdings on the whole they tend to demonstrate similar performance and returns. The chart below compares the performance of three key BRIC ETFs: the streetTRACKS SPDR S&P BRIC 40 ETF (AMEX:BIK), iShares MSCI BRIC Index ETF (NYSEArca:BKF), and the Claymores Bank of New York BRIC ETF (NYSEArca:EEB).

Despite much discussion of the de-linking of the BRIC economies to the West (a view that proclaimed the independence or near independence of the BRIC economies) from a market perspective this has yet to out-muscle the opposing trend: toward an increasingly connected world. Correlation of the performance of BRIC ETFs in comparison to the domestic benchmark Standard and Poor's Depositary Receipts (AMEX:SPY), which tracks the S&P 500 Index, tends to be quite high. Claymore's EEB was the first BRIC to market and thus has most of the market share. The chart below uses EEB to make this comparison. It shows that on a 1-year basis EEB has an R-squared correlation coefficient of 0.89 (where 1 represents perfect correlation and 0 represents no correlation), in other words that BRIC ETFs are highly correlated with the US benchmarks.

So with this kind of correlation why should investors bother with a BRIC ETF? The answer of course is that correlation is not the same as performance. BRICs are the fastest growing economies in the world. China is growing at around 10% per year, India is growing at 8-9%, Brazil and Russia 5-7%. These rates are not constant and of course depend on healthy participation of Western economies, but increasingly these countries are becoming increasingly important inputs into the world system. If in the new order of the first decade of the 21st Century the U.S and Europe emerged as the worlds consumers, then China the became the worlds preeminent manufacturer, India the worlds service outsourcer and Brazil and Russia essential commodity and natural resource providers. That explanation is over simple but a diversified portfolio should probably reflect the reality of a global system where BRIC countries play big roles.

But the volatility in BRIC ETFs can be daunting. Chinese ETFs like iShares FTSE/Xinhua China 25 Index (NYSEArca:FXI) are notorious for their volatility and high betas. FXI has a beta of close to 2, which means that for every percentage point move in the SPY, FXI moves 2 percentage points. Less well known and less appreciated is that the pure play Brazilian ETF iShares MSCI Brazil (AMEX:EWZ) has a similar risk profile. When oil prices fall rapidly, Russian markets are so volatile that they on several occasions exchanges have been completely closed down, sometimes for days at a time. Historically this has not prevented the BRIC ETFs from trading, though it certainly has added to their volatility.

From an expense ratio perspective all three of these funds are pretty efficient at providing exposure to the BRIC economies. BKF has the highest expense ratio at 0.75%. EEB is at 0.7%, and at 0.5% BIK has the lowest of the three. Turnover adds to the expense of some ETFs, and is a kind of stealth expense for funds that do a lot of trading. These funds however all have very minimal to zero turnover.

Allocation by country tends to be a little different in each case and will vary of course with performance. All three ETFs are heavily weighted (65%-85%) to China and Brazil, with India and Russia generally underrepresented. In part this reflects the enormous size of the Chinese economy in comparison with the other BRICs. This skewing is particularly stark in the case of EEB where Russia typically composes less than 5% of the fund, and India around 10% of the fund. BKF tends to have the most equal representation by country with Russia and India together composing around 30% of the total ETF.

Allocation by industry tends to be more similar among these funds, with industrial, energy, telecommunication, and financial stocks dominating. BIK is the most concentrated of the three holding just 40 stocks to BKF's 124 companies. The high number of holdings in BKF is somewhat misleading however as its top ten holdings constitute about 40% of overall holdings (compared to around 50% of overall holdings for BIK and EEB).

Some investors may ask whether or not the BRIC designation, and perhaps the booming BRIC economies more generally, are perhaps an investment fad. Is the excitement that these economies generate only possible in a world-wide bull market? Is the viability of this asset class more characteristic of a global optimism than of an economic reality? The answer is that the BRIC economies are world-class and they are growing. They are obviously linked to the West, but they are just as obviously increasingly strong domestically. Because of their high betas, BRIC ETFs have a tendency to overshoot the domestic market benchmarks like the SPY. This makes them dangerous to own when the market is peaking but significant opportunities, both the short and longer term, when the market finds a bottom.