Saturday, August 25, 2007

How To Construct a BRIC-Tracking Portfolio

I have previously written about the tremendous projected growth of the emerging markets of Brazil, Russia, India, and China (see posts from January 2007 and May 2007). Rapid economic development in each of these countries is projected for decades to come. As I mentioned back in January 2007, Goldman Sachs published a report in 2003 on the BRIC countries and projected that the economies of these countries will grow much faster than any of the current developed markets (including the U.S., Japan, Germany, the U.K., Italy, and France) and the local currencies of the BRIC countries will appreciate some 100-300% against those of the developed markets.

There are popular relatively low-cost emerging markets ETFs currently being offered, such as the iShares MSCI Emerging Markets Index Fund (symbol: EEM), which tracks the MSCI Emerging Markets Free Index. Another popular emerging markets ETF is the Vanguard Emerging Markets ETF (symbol: VWO), which tracks a slightly different emerging markets index, MSCI Emerging Markets Select Index. Both the iShares and the Vanguard ETFs are a good way to invest in emerging markets. However, both invest only around 40% of their assets in the BRIC countries.

I have been waiting for some time for a good BRIC ETF to be introduced that invests only in the BRIC countries. So far, two BRIC ETFs are trading on the market. The oldest is the Claymore BRIC ETF (symbol: EEB), which tracks the Bank of New York's BRIC Select ADR Index, as I discussed back in January 2007. The other BRIC ETF is the SPDR S&P Bric 40 ETF (symbol: BIK), which was introduced in June 2007 and tracks the S&P BRIC 40 Index.

Although I am glad that BRIC ETFs are finally available, I do not like either of the currently available BRIC ETFs. According to ETFconnect, the Claymore ETF invests in the BRIC countries according to these allocations:
  • India - 13.56%
  • China - 35.79%
  • Brazil - 45.88%
  • Russia - ???? (possibly 4.77%)
The S&P BRIC ETF invests in the BRIC countries according to these allocations:
  • India - 6.70%
  • China - 40.05%
  • Brazil - 26.75%
  • Russia - 25.05%
I don't like either of these BRIC ETFs because they both over-allocate investments in certain BRIC countries at the expense of other investments in other BRIC countries. For example, I fail to see the logic behind the index tracked by the Claymore ETF investing less than 5% in Russia stocks, or the index tracked by the S&P BRIC ETF investing only about 6.7% of assets in Indian stocks.

I would prefer to see a BRIC ETF that invests about 25% of assets in each of the BRIC countries. Country-specific ETFs and ETNs are available for small investors to create their own relatively low-cost BRIC-tracking portfolio. I personally would invest according to the following allocation:
In order to minimize transaction costs, I would invest via a low-cost brokerage, such as Ameritrade Izone, which only charges $5 per trade. I would also purchase a minimum of $1500-2000 of each security at the time I create the portfolio, and I would rebalance once per year. Because of the inherent volatility of emerging markets, I would probably limit a BRIC investment to 5-10% of my overall portfolio.

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