In October 2003, Goldman Sacks published a research paper titled, Dreaming with BRICs: the Path to 2050." The paper states that Brazil, Russia, India and China, commonly referred to as BRIC, may rank among the worlds most dominant economies by mid century. By 2041, Chinas Gross Domestic Product (GDP) could possibly be greater that the United States and larger than everyone else except Japan by 2016. The BRIC economies together might be larger than the G6 (US, Japan, UK, Germany, France and Italy) by 2039. Obviously, there are execution risks, but the trends are in place for this to occur. This has enormous implications. As these countries develop, just think of how their people will benefit and the opportunities that will be created. Demand for items that developed countries middle-class have come to expect will be tremendous. Consumer items such IPODs and DVD players will be of interest, but that will pale in comparison to the demand for housing with indoor plumbing, electricity, basic appliances and cars. In Goldman Sachs follow-up report released in 2004, it states that between 2005 and 2015 over 800 million people in these countries will have crossed the annual income threshold of $3000. By 2025, approximately 200 million people in these economies will have annual incomes above $15,000. So, how can we as investors benefit from the industrialization of BRIC? I would like to propose two approaches: direct and indirect investing into the emerging economies. Direct investing requires an in-depth knowledge of companies in complex and diverse countries. This is far too time-consuming for the average investor. A much simpler approach would be purchasing single-country exchange traded funds (ETFs). I realize this is a mouthful. Lets start by defining exchange traded fund (ETF). It is a fund that tracks an index, but can be traded like a stock. Thus, it provides the diversification of a mutual fund, but is not hampered by trade cut-off times and early redemption fees. A single-country ETF is linked to a countrys index that reflects the value and composition of its specific stock market. ETFs of the BRIC countries include: Brazil (EWZ), Russia (TRF), India (IFN), and China (FXI). Their year to date performance (YTD), as of 6/30/2006, is 17.2%, 27.4%, 16.3% and 24.6% respectively. This produces an equally-weighted return of 21.8%. Trouncing the US Major indices returns of 4.0%, 1.8%, and -1.5% (DOW, S&P 500 and NASDAQ respectively). The second approach, indirect investing, consists of investing in companies that supply materials and equipment that the BRICs will need to industrialize. Imagine the number of highways, bridges, railways, factories and skyscrapers that will need to be built. This is impossible without commodities such as iron and carbon that are combined to form steel. Modern society requires copper for electricity and information technology. Can you imagine how much cement and concrete will be consumed? The demand created for these and other commodities will be phenomenal. To leverage this approach I have created a basket of 12 stocks. It contains proven industry leaders that produce or supply to companies that extract base metals from the earth. Base metals include Copper, Aluminum, Nickel (stainless steel and nickel metal hydride batteries), Zinc (anti-corrosive coating in galvanized steel) and Lead (lead-acid car batteries). Companies that mine base metals include: diversified producers BHP Billiton (BHP), Falconbridge (FAL), Rio Tinto (RTP); aluminum producer Alcan (AL); copper producers Freeport-McMoran (FCX), Southern Copper (PCU), Phelps Dodge (PD); nickel producer Inco (N); iron ore producer Companhia Vale Do Rio Doce (RIO). The suppliers of equipment, parts and services to these companies will profit as well. Thus, I have included two heavy equipment manufacturers in the portfolio: Caterpillar (CAT) and Bucyrus International (BUCY). The final company is not a base metal producer or supplier, but countless tons of cement and concrete will be necessary for the build-out. Therefore, I have included cement and concrete producer Cemex (CX) in the basket. This indirect approach, using an equally weighted portfolio of the above listed stocks, has outperformed the direct approach 27.2% vs. 21.8% year to date. In closing, I would like to share a couple of implementation details with you. The above portfolios are intended to be traded as a basket meaning that all should be bought and sold at the same time. Cherry-picking a couple of stocks may not produce better results the diversification reduces company or country specific risk. It is also important to choose the right brokerage to employ this strategy. I have found that FolioFn lends itself well to this strategy. It enables complete automation of the process by supporting single-order basket trading as well as automatic dollar cost averaging. I highly recommend combining this strategy with dollar cost averaging. For more information on the benefits of dollar cost averaging, refer to my article on "Double Digit Gains with Dollar Averaging." Commissions on a large basket can be cost prohibitive. Foliofn address that with its various commission plans including one that allows up to 600 window trades per month for $30. Consequently, fees on accounts of $40K would be less than 1% per year using this plan. This puts fees of basket trading in-line with fees of ETF and much better than mutual funds. There is a tremendous opportunity to make money investing in the BRIC thesis. What are you waiting for? Reference:
Dreaming with BRICs: the Path to 2050." |
