CHICAGO The worst advice on emerging markets is to go out and buy the best-performing funds or countries of last year. In most cases, the hot money has come and gone and you can't buy yesterday's gains. But you can invest in a wide basket of developing countries to build a more robust portfolio foundation.
That's not to say that emerging markets aren't worthwhile. For global investors in the past decade, it's been accepted wisdom that investing in the BRIC countries of Brazil, Russia, India and China is the basis of a strong strategy. While that's still somewhat true, it's not monolithic. Russia has had its setbacks and India is slowing down. China's economy has increasingly raised the concern of international analysts.
But what's left? Jim O'Neill, the chairman of Goldman Sachs Asset Management who coined the BRIC acronym a decade ago, suggests expanding your horizons to include Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey and Vietnam.
Global wealth seems to be moving to locales that have not been traditionally seen as bastions. While London and New York are still holding their own, high-net-worth individuals are investing in off-the-beaten track cities like Nairobi, Jakarta, Vancouver, Tel Aviv, Kiev and Cape Town. That's according to a recent Wealth Report prepared by Knight Frank and Citi, which tracked global residential and commercial property hotspots (link.reuters.com/jav87s).
Countries that have benefited from money moving from first-tier developed nations into emerging economies include Thailand, Colombia, Indonesia, Malaysia and Singapore. According to an analysis by Lipper, a Thomson Reuters company, exchange-traded funds that invested in those countries easily trounced the BRIC strategy over the past three years through April 20.
Single-country targeted funds include the iShares MSCI Thailand Investable Market Index ETF, which led the pack of emerging markets ETFs with a 47-percent three-year return, Lipper found. The Global X FTSE Colombia 20 and Market Vectors Indonesia Index returned 42 percent and 41 percent, respectively, for the period.
How did these developing countries compare with a BRIC fund such as the Guggenheim BRIC fund. The exchange-traded fund returned a respectable 18 percent for the period, although it was less than half of the performance of the high flyers. Broader, more conservative portfolios make more sense. Consider the PowerShares FTSE RAFI Emerging Markets Portfolio if you want to slightly underweight China, which dominates most ETFs specializing in emerging markets. The WisdomTree Emerging Markets Equity ETF has more than three quarters of its holdings in Latin America and Greater Asia.
O'Neill insists that the BRICs are still headed for explosive growth long term. In terms of relative GDP growth and size, "China produces another India every 18 months or another Italy every 15 months," O'Neill said at a meeting of the Chicago Council on Global Affairs on April 26. O'Neill's likely right about BRIC growth - if current trends continue.
But a global economic retrenchment is still possible, especially when you watch the debilitating euro zone austerity measures and the inability of the U.S. Congress to cut its growing budget deficit. And China is actually one possible weakening link in the BRIC strategy. The world's most populous country is still on track to become the world's largest economy in the next two decades or so, but its ascent may not be a clean, straight line.
A recent report by BlackRock, Inc., which manages more than $3 trillion in assets, suggests that China may encounter some rough patches, although it didn't predict how these gremlins will slow the burgeoning Chinese economy (link.reuters.com/hav87s).
BlackRock's analysts pointed to China's real estate slump as the "biggest threat to economic growth and confidence in 2012." The firm said research from the Peterson Institute showed that real estate accounted for some 40 percent of urban household wealth in 2010 - double what it had been in 1997.
Did China overbuild and create a bubble? The BlackRock report isn't definitive, although it noted "we struggle to find a precedent in history where the bursting of the bubble did not lead to financial distress." The researchers also highlighted other red flags such as an explosion in credit growth, its undervalued currency relative to the dollar and the slow move toward a consumption economy.
Slower global economic growth, though, remains the major roadblock to BRIC countries. Energy-rich Russia felt a big pinch as its gross domestic product growth rate slowed to 3.2 percent year-over-year in March, down from 4.8 percent in February.
Brazil, which is still expanding due to its natural resource wealth, recently cut benchmark interest rates in an attempt to revive its sluggish economy, which once was keeping pace with China's 7-percent-plus rate. India is faring even worse with the credit ratings agency Standard and Poor's downgrading India from "stable to negative" in light of the country's growing deficit and diminishing growth.
So to truly internationalize and balance your portfolio, you need to move beyond the BRIC strategy to find robust growth in smaller, overlooked countries. A broader-based approach, which is what I employ in my portfolio, will net you more growth.
(Editing by Beth Pinsker Gladstone and Andrew Hay)