We investors know BRIC stands for Brazil, Russia, India, and China. This BRIC label clubs all four distinct but emerging markets into a single entity. Based on this acronym there are many different mutual funds, closed-end funds, and ETFs. Each of these countries are different in many ways such as different governance structure, different governance policies, different types of economies, different strengths, different financial markets, different values, etc., Even with these differences they are clubbed together and viewed as single entity for investing in emerging markets.

To me, it does not make sense to club BRIC together for investing purposes. Each country should be looked at individual entity. China continues to receive most attention in the press, however, I believe its India that provides a much better option for small individual investors. Following are three reasons I believe India has relatively more fundamental strength than other countries.

• Inward Consumption Based Growth: India’s economy is consumption oriented when compared to other emerging markets. India’s export contributes less than 15% to its $1.2T GDP. The IT outsourcing services and back office has garnered most of the business media coverage; however, these industries have less than 8% contribution to the GDP and employ less than 5 million people. This is an indicator of growth by internal production and consumption. It is less reliant on exports. Quite contrarily, these technology services perform better in recession, because it is all about optimizing operational cost.

• Conservative Central Bank: Its Reserve Bank (a.ka. central bank) has very conservative monetary policy, which is why we did not see failure of the banks (or banking system) during recent financial melt down. There were no widespread bank bailouts.

• Transparency: It has democratic governance which on many occasions slows down the decision making progress, but provides better transparency (relative to Russia and China). As of today, its currency is freely convertible for trading goods and services, but there are certain restrictions for international asset acquisition. However, it has a pragmatic roadmap to allow its currency to fully float with market dynamics. In 2007 and 2008, when Dollar dropped against Indian Rupee, Indian export started becoming uncompetitive.

• Government Stimulus Driven Growth is Less: The Indian market has rebounded in line with other emerging markets like China or Brazil. An earlier fear of bubble seems to be a just – a fear. It’s economy indicator suggest it is back of growth. The key in this rebound is; not much is being supported by government driven expenditure or public infrastructure projects. In fact, it continues to stumble on its infrastructure.

Finally, India can boast that its government is run by a bunch of prominent economists (with political and public support). The architect of Indian economic reforms, who laid down the path for reforms 18 years ago, is now at its helm as a prime minister. It is always good to have a non-political leader who is not only an economist, but someone who knows how to execute it in the complex state like India. Therefore, I continue to believe that on long 10+ year time horizons my dollars are (a) relatively safer; and (b) provide above average returns in Indian markets. I do not expect to be a smooth ride. There will be time period when markets will crash, but it will eventually come out stronger.

Having said that, I believe, individual investors should use ETF based investment vehicles for India (or any other emerging markets) which invest in array of companies and have less fees and commissions. Keeping with this thought process, I use Wisdom Tree India based ETF, EPI. You may read more about my reasons for selecting EPI for this objective.

Few weeks ago, I posted an article earlier which discussed why emerging markets (e.g. BRIC) cannot be clubbed together. There are so many significant differences that it makes sense to look at it individually. Most likely it will also provide maximum possible return for our invested dollars. While China continues to receive most attention in the press, I believe its India that provides a much better option for small individual investors. Following are three reasons I believe India has relatively more fundamental strength than other countries.

• Inward Consumption Based Growth: India’s economy is consumption oriented when compared to other emerging markets. India’s export contributes less than 15% to its $1.2T GDP. The IT outsourcing services and back office has garnered most of the business media coverage; however, these industries have less than 8% contribution to the GDP and employ less than 5 million people. This is an indicator of growth by internal production and consumption. It is less reliant on exports. Quite contrarily, these technology services perform better in recession, because it is all about optimizing operational cost. In addition, its reserve bank (a.ka. central bank) has very conservative monetary policy, which is why we did not see failure of the banks (or banking system) during the current financial melt down. There were no widespread bank bailouts.

• Transparency: It has democratic governance which on many occasions slows down the decision making progress, but provides better transparency (relative to Russia and China). As of today, its currency is freely convertible for trading goods and services, but there are certain restrictions for international asset acquisition. However, it has a pragmatic roadmap to allow its currency to fully float with market dynamics. It has demonstrated international policy of non-confrontation which, to certain extent, immunes its economy from international squabbles.

• Government Stimulus Driven Growth is Less: The Indian market has rebounded in line with other emerging markets like China or Brazil. While it remains to be seen whether it can be sustained, the indicators suggests it may not hit similar level of bottoms again. A recent article showed rebound of earnings for companies in its SENSEX index. The key in this rebound is; not much is being supported by government driven expenditure or public infrastructure projects. In fact, it continues to stumble on its infrastructure.

Finally, India can boast that its government is run by a bunch of prominent economists (with political and public support). The architect of Indian economic reforms, who laid down the path for reforms 18 years ago, is now at its helm as a prime minister. It is always good to have a non-political leader who is not only an economist, but someone who knows how to execute it in the complex state like India. Therefore, I continue to believe that on long 10+ year time horizons my dollars are “relatively” safer in India markets than any other emerging markets. I do not expect to be a smooth ride. There will be time period when markets will crash, but it will eventually come out stronger.

Having said that, I believe, individual investors should use ETF based investment vehicles for India (or any other emerging markets) which invest in array of companies and have less fees and commissions. Keeping with this thought process, I use Wisdom Tree India based ETF, EPI. You may read more about my reasons for selecting EPI for this objective.

In last five years or so, Exchange Traded Funds (ETFs) have grown in numbers and it asset values. In my view, ETF is another form of investing vehicle available (among many others) to investing or trading community. The major attraction for ETF has been low cost expenses and fees in comparison to mutual funds and ability in trade during market hours. Like any other investing vehicles, I believe ETFs are good vehicles depending upon how/why an individual investor uses in its portfolio. The simplicity with which you can buy and sell an ETF makes it even more difficult to understand how it is structured, what are its constituents, etc., So before you buy an ETF you much understand why you want to buy it and what role it plays in your portfolio. Broad market exposure and access to alternative assets are two important roles ETF can play in your portfolios.

• Broad Exposure: ETFs are very good investment vehicle for hedging against broad market performance, broad industry sector, broader country exposure, or any particular asset class. When investing in ETF, investors need to make sure that it represents its intended objective. Many ETFs just invest in few bunch of stocks and expect only those small number of stocks to provide broader exposure. In my viewpoint, ETFs for broad exposure should consist of more than 250 or 300 stocks.

• Access to Alternative Assets: This is one the significant benefits depending upon how the ETF is constructed. E.g. ETFs based funds for leverages, currencies, commodities, futures, etc are being made available. However, I believe that such ETFs are high risk opportunities. I am not advocating the use of such assets, but merely pointing the fact that such asset classes were not available earlier. Whichever theme one chooses, I believe the asset in ETFs should be basket of stocks or businesses dealing in those particular domains.

ETFs can play these two roles successfully if investors are investing for long haul and understand their structure.

• Time Horizon: Investment in ETFs should be for long haul. The time horizon should be in the order 10 years, 15 years, or even more. The true benefit of investing ETF is derived when investing for long term. One of the methods to invest in ETF is dollar cost averaging over a period of time. There is a school of thought that investors should buy when an ETF is below intrinsic value or relative PE is less than one. In my view for individual investor, it is next to impossible or futile to go into this exercise. Keep it simple, and hence buy and/or continue to add when it is below 200 day and 365 day moving average.

• ETF Structure: Understand what an ETF consists of, e.g. common stocks, futures, options, leverages, etc. Many ETFs are closed end funds with high expenses, many provide dividends that include return of capital, many provide short term gains distributions (tax implications), many consist of only 30 or 40 stocks based on capitalization, etc. In addition, investors need to more careful for ETF focusing on emerging markets. Many funds just invest in ADR/GDR/ADS, which is locally available in US and still charge high fees, many only have less than 100 stocks, etc.

Strategically, ETFs can provide a means to strengthen investors portfolio and help in asset allocation. At this point in time, I believe ETFs are the best investment vehicles to get exposure to a broader emerging markets. Investors do not need to worry about identifying countries or individual companies in emerging countries. They not only provide individual investors a means to invest, but also a mechanism to buy and sell easily during trading hours.

What role does ETF play your portfolio?

This article was first published on The DIV-Net on October 16, 2009.

TIP Guy at TIPBlog.in presented his thoughts on how dividends are perceived at least in India’s corporate world. I am reproducing certain snippets (with author’s permission).

The lack of consistent dividend growth companies in emerging markets can be interpreted in different ways

1. Emerging economies need very dollar to invest back in their businesses. The cost of external capital is typically higher, and hence it is advisable to use internal resources. Shareholders can get their return by capital appreciation on their share values.
2. The managements are not mature enough to understand the importance of common shareholders, or sharing a piece of profits with shareholders, and/or prudent cash management over longer term.
3. The taxation policies which do not favor dividend distributions.

I believe most of the corporations in emerging markets are personality driven, and lack any institutional management philosophy. The corporations are primarily driven by personal aspirations (both, good and bad), and as a result the shareholders have miniscule holdings (and contributions). I cannot recall any instance where majority shareholders (other than family and friends) or banking institutions that have been able to make any change. And hence, this has a part in driving the dividend strategies. Common shareholders have such a small percentage holdings that they always remain in back burner.

There are approximately 400 companies in India that have at least paid dividends for last 10 years. However, they have not been growing consistently. Furthermore, the dividend strategies also hinge upon governments taxation policy and cost of available capital. I believe as that as Indian economy grows and competition increases, the cost of capital will come down, and taxation policy will evolve slowly towards friendlier dividends. As of today, at least the dividends are tax free for individuals.

Certainly, there are issues about Indian corporate’s dividend friendliness. However, there are 400 companies that still pay dividends. If we look back 30 or 40 years, I tend to believe that’s how US companies and corporate may have viewed the dividends. As US economy matured, few selected companies continued to follow their strategy resulting in Aristocrats’ and Achievers. While I tend to agree that, over time, Indian corporate may evolve towards dividend friendliness, I do not think it is at a point where they can be attractive on its own. There is promise, but not yet.

Until then I believe using US-based multinationals that generate revenue from emerging markets are best proxy for investing in emerging markets. Some examples are:

• QCOM (my analysis)
• BDK (my analysis)
• CBY (my analysis)
• INTC (my analysis)
• ADM (my analysis)
• PG
• UL/UN
• Nestle

What investment vehicles do you use for investing in emerging markets?

Almost all do-it-yourself investors who are reading about emerging markets would be aware of BRIC acronym. BRIC stands for Brazil, Russia, India, and China. This BRIC label clubs four distinct emerging markets into a single entity. Based on this labeling, there are many different mutual funds, closed-end funds, and ETFs. What is ironical is there is no similarity except that they are supposed to be the new growing economies. Each of these countries have different governance structure, different governance policies, different types of economies, different strengths, different financial markets, different values, etc., Even with these differences they are clubbed together and viewed as single entity for investing in emerging markets. This is again one of the follies of Wall Street investment firms (think GS!). To top it off GS and other investment firms seems to have more lenient bent towards China’s market among the BRICs. Is this because these firms get more business in China? I am not sure if there is an open answer to this one. But clubbing all these countries under BRIC acronym does not make sense to me.Russia and China seem to have similar ambitions of having a dominant say in world affair, be militarily or economically. However, both seem to be following different paths to reach there. Russia wants to go military way using its natural resources (particularly oil), with scant regards for well being of its population. How about Russian democracy? We all know its democratic governance (pun intended)! Without oil, its economy seems to flatter. China seems to be attempting the path of economic leverage to have its dominating standing in world affairs. It is happy engineering numbers for its advantage. Democracy in China is non-existence. Ironically, we in US want to establish democracy in Arab countries, but happily gloss over at China’s democratic record. China’s export oriented manufacturing economy is quite different than Russia’s oil economy. China’s cheap exports contribute one third to its $4T GDP, while Russia’s exports contribute to one fourth to its $2T GDP. Can Russia and China be clubbed? Are their financial markets open enough for investors?

On the other hand, Brazil and India does not seem to aspire for dominance in world affairs. Both of these countries are perhaps only looking for recognition and say in world affairs. Brazil economy seems to be driven by natural resources, demographics, and internal consumption. Similarly, Indian economy is driven by its demographics and internal consumption. Brazil’s export contribution is less than 10% to its $2T GDP, while India’s export contributes less than 15% to its $1.2T GDP. Furthermore, Brazil and India follow a democratic governance which on many occasions slows down decision making, but provides better transparency to some extent (relative to Russia and China). Which one would you choose; uncertainty of bad or good in China/Russia and knowing how to manage risk; or knowing bad habits of Brazil/India and entering with risk management?

As you can see, there are fundamentally significant differences in BRIC nations. According to me there is no way one can club these countries together. This is once again a delusional concept purported by financial firms to sell their fund-based products. This BRIC label does not have any fundamental basis other than emerging markets. There are thousands of companies in all four economies, and clubbing all together to preparing a representative fund of few tens, or few hundreds does not make sense to me. Also, the idea that one can capture and hedge by investing in BRIC based funds is something that I cannot understand.

Investors interested in emerging markets should be: (a) looking at countries on individual basis; (b) using ETF based investment vehicles; and (c) maintaining allocation according to risk appetite. On a personal front, I am interested in Indian markets for its sustainability and hence use wisdom tree’s EPI as an investment vehicle. In addition, my maximum target allocation for emerging markets is 8% or less.