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A Rough Ride on BRIC Road

Funds stumble trying to capitalize on a big idea.

Gregg Wolper, 03/19/2013

Goldman Sachs recently announced that Jim O'Neill, chairman of Goldman Sachs Asset Management, is retiring. As every article about his impending departure noted, O'Neill gained attention for coining the BRIC acronym in November 2001. In a Goldman Sachs research paper, he argued that because Brazil, Russia, India, and China were so important economically, and would become even more so in the coming decade, they should have a place in global decision-making bodies such as the G7.

Criticism of the BRIC concept soon arose. Why lump together such disparate countries, ignoring other fast-growing emerging markets, and assign them an easy-to-remember acronym, unless there's more than a hint of self-promotion involved?  Was this just Goldman Sachs trying to essentially trademark the idea that China and other big emerging markets would continue to grow?

Some of the cynicism was justified. Even so, viewed from today's perspective, O'Neill was on target in broad terms. Led by China, these four countries have become far more central to every discussion of important issues than they had been, from the outlook for global economic growth to debates about energy production and climate change to forecasts of stock-market performance and currency movements.

And in the narrow sense, O'Neill did succeed in making the BRIC acronym commonplace. It even made the jump from idea to reality when the four countries began holding summit meetings, which now include South Africa. (For an excellent discussion of O'Neill and the BRIC concept, see Gillian Tett's 2010 story in the Financial Times.)

As with many trendy ideas, though, things got sticky when fund companies tried to turn the BRIC concept into investment vehicles. The first publicly available open-end BRIC mutual funds in the United States were not launched until the summer of 2006, when Franklin Templeton and Goldman Sachs each brought out a BRIC-focused equity offering. By the end of 2007, three index-tracking exchange-traded BRIC funds were available as well.

How have these BRIC offerings fared? For the actively managed Goldman and Templeton funds, the answer is simple: badly. For the ETFs, the story is mixed. Moreover, the vast differences in mandates among funds ostensibly following the same straightforward concept illustrate that the risk of weak performance isn't the only complication in turning an idea into a real, logical, and successful investment vehicle.

The Mutual Funds: Nothing to Write Home About
Goldman Sachs BRIC GBRAX opened in June 2006, a few weeks after Templeton BRIC TABRX. Overall, the Goldman fund's performance has been dismal. Its 4.9% annualized return from inception through March 13, 2013, is nearly 2 percentage points worse than the average for the diversified emerging-markets category. The fund's showing lags even further behind the performance of a broad, cheap emerging-markets index-tracker, Vanguard Emerging Markets Stock Index VEIEX.

The history of Goldman Sachs BRIC does include some sweet spots. It enjoyed outstanding gains during the huge rallies of 2007 and 2009. But it has been crushed when markets sank, and it failed to keep up in 2010's upturn. The fund's trailing five-year return, which doesn't include 2007's success, lands in the category's bottom 10% and trails the group average by more than 4 percentage points, annualized.

Some might argue that the fund should not be judged against the diversified emerging-markets category average and a broad emerging-markets index fund. After all, the Goldman fund is limited to four countries. But it makes sense to compare its performance with the broader emerging-markets offerings. Many people who choose a narrower emerging-markets fund, whether focused on Asia, Latin America, or the BRIC markets, are probably using money that would have gone to their broader emerging-markets fund, or perhaps instead of owning a broader emerging-markets fund.

That said, it's also worth checking the fund's performance against that of a BRIC index. It turns out that Goldman Sachs BRIC has been lousy by that measure, too. Since inception, it lags the MSCI BRIC Index, its chosen benchmark, by nearly 2 percentage points, annualized.

One reason: the fund's high cost. Emerging-markets funds often have steep price tags, but the expense ratio on this fund's A shares, 1.82% in 2012, is high even by that standard. The fund was even more costly in previous years. The Institutional shares are also more expensive than their comparison group.

The story at Templeton BRIC is even less inspiring. Since its 2006 inception, this fund has lagged the diversified emerging-markets category average, the Vanguard Emerging Markets Stock Index fund, and the MSCI BRIC Index, trailing each by 3 percentage points or more (annualized). Like the Goldman fund, Templeton BRIC currently sits in the bottom decile of the diversified emerging-markets category for the trailing five years.

This fund's expense ratio has also been a problem. Templeton BRIC cost a frightening 2.02% in 2012. Its expense ratio ranged between 2.09% and 2.17% in the four previous years.

The ETFs: A Mixed Picture
All three exchange-traded funds that target the BRIC countries are more than five years old, so their histories can be instructive as well. Each is an index-tracker, but they follow different indexes. These offerings have racked up better performance than the active funds, in relative terms, but only one stands out in that regard.

Guggenheim BRIC EEB came out in September 2006, and its annualized return from inception to March 13 is 8.3%, far better than the diversified emerging-markets category average and the Vanguard Emerging Markets Stock Index fund. However, before you decide that investing in a BRIC fund works well after all, as long as you choose an ETF rather than an actively managed option, note this: The Guggenheim fund targets only a particular slice of the BRIC markets. Its universe includes only BRIC stocks that are available as ADRs or GDRs. That quirk makes its portfolio much different from those of other BRIC funds. Whether that atypical makeup will continue to pay off isn't clear.

By contrast, iShares MSCI BRIC Index BKF, which came out in November 2007, has not fared well. With a 4.7% annualized loss since inception, it lags the diversified emerging-markets category and Vanguard Emerging Markets Stock Index by wide margins. The third ETF, SPDR S&P BRIC 40 BIK, has beaten the category norm by less than a percentage point since its mid-2007 inception and is essentially tied with the broader Vanguard index-tracker's returns.

A Rocky Road From Idea to Investment
O'Neill's 2001 paper--which, it should be noted, focused on GDP growth and political representation, not stock-market performance--did have some merit. Converting a concept, trend, or idea into a usable, profitable investment isn't a smooth or guaranteed process, though, even when the investment vehicle is offered by the same firm that pioneered the concept.

In the case of the BRIC funds, three issues stand out. First is cost. With expense ratios nearing or exceeding 2% a year, the two actively managed funds consistently faced a major hurdle. Even the ETFs have to contend with expense ratios that currently range from 50 to 69 basis. Compare that to the Admiral and ETF share classes of Vanguard Emerging Markets Index, which have expense ratios of 18 basis points.

A second complication is that you can't buy a country. You can't invest in GDP. These funds couldn't just "own" the four BRIC markets; they had to come up with specific portfolios--which in some respects differ markedly from one another. (For example, the Guggenheim fund has a much higher weighting in Brazil than the others do, and the SPDR ETF owns just 40 mega-cap stocks, giving it the most compact portfolio and the biggest market cap by far.)

Third, in the actively managed funds the portfolio managers have to choose specific securities to own, assign them appropriate weightings in the portfolio, and buy and sell them at opportune times. The evidence indicates that the Goldman and Templeton funds have fallen far short on this score.

A final note: Observant readers may have noticed that these companies did not launch their BRIC funds soon after O'Neill's paper appeared in November 2001. Rather, they waited until 2006 or 2007, when emerging markets were already in their fourth and fifth years of a stupendous rally. (Vanguard's emerging-markets fund gained 26% or more every year from 2003 through 2007.) If a concept fund is coming out when the concept is almost half a decade into a monster rally, consider that one more reason to think very carefully before climbing aboard.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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