BRICs In The Wall

Courtesy of The Financial Times, a look at the performance of smaller emerging markets around the world:

“…While the Brics make headlines, smaller markets can often give investors a better return. The problem is that a small market can be more volatile – too many eggs in Thailand can be riskier than too many in China.

But a basket of smaller markets is a different matter. State Street Global Advisors has calculated that a group of smaller EMs outperformed the Brics in equities by 39 per cent over 14 years. That’s worth going for. But there are catches – smaller markets offer less liquidity and less stock choice.

The US fund management company, which has about $75bn in assets under management in EM equities, looked at the performance of 11 smaller markets from the end of 1996 – Colombia, Egypt, the Czech Republic, Peru, Hungary, Turkey, Chile, Poland, the Philippines, Thailand and Israel (although Israel was dropped last year when it graduated from the MSCI emerging markets index).

Portfolio manager Chris Laine chose the countries on the basis that they accounted for a maximum of 2 per cent of the MSCI emerging markets index and their stock markets were not overly dependent on a handful of dominant stocks (as is the case, for example, in Morocco, with Maroc Telecom).

Mr Laine’s report says: “The rise of the emerging markets is more than just a Bric story. Investors, while maintaining a core exposure to these Bric economies, should not close their eyes to other growth areas in the emerging world.

“Many of the smaller emerging and frontier economies have quietly been making investor-friendly reforms and deserve the attention of international investors. Many of these economies offer value, growth, and solid profitability, but certainly with some challenges [liquidity, investability, and volatility to name a few].”

Mr Laine estimates that his 10 countries account for about 10 per cent of the MSCI EM index and he advises investors to go overweight and hold up to about 15 per cent of their EM equity portfolio in these markets. But it is horses for courses – big funds may have trouble building sufficiently big positions because of the lower levels of liquidity than in Bric markets.

Curiously, as well as the greater capital appreciation, the smaller markets offer better dividend yields – 2.8 per cent versus 2.1 per cent for Brics. Looking forward, Mr Laine suggests that smaller markets should continue to do better than Brics because they tend to perform better than the MSCI EM benchmark index.

But diversification is the key. He warns against trying to pick one small market over others, particularly in the light of the recent upsurge in unexpected events, notably the turmoil in the Middle East. “A high level of diversification should always be in fashion.”

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Wildcats & Black Sheep is a personal interest blog dedicated to the identification and evaluation of maverick investment opportunities arising in frontier - and, what some may consider to be, “rogue” or “black sheep” - markets around the world.

Focusing primarily on The New Seven Sisters - the largely state owned petroleum companies from the emerging world that have become key players in the oil & gas industry as identified by Carola Hoyos, Chief Energy Correspondent for The Financial Times - but spanning other nascent opportunities around the globe that may hold potential in the years ahead, Wildcats & Black Sheep is a place for the adventurous to contemplate & evaluate the emerging markets of tomorrow.