To continue what seems like a series on chopping up asset classes into various investable components such as commodities and emerging markets I want to dig a bit deeper into the emerging market space, but specifically into the often cited BRIC nations (Brazil, Russia, India, China).Let’s start with a basic returns table for comparing a BRIC index and its 4 components with the MSCI EM Index (all in USD):

click to enlarge

The monthly return data used for this table goes back starting at December 31, 2001 but the Brazil, Russia and China index data only goes back to a starting value as of April 30, 2002 thus no 5-year returns for them in the above.

Pretty darn spectacular in what has been a pretty darn spectacular global bull run over the past 4 years. As usual, I now break out the charts starting with a comparison of the BRICs versus the MSCI EM Index:

So $1,000 grows to roughly $4,250 with the BRICs versus roughly $3,250 with an ETF like EEM. Clearly, a significant difference. So, now we see why that is:

So instead of comparing the MSCI EM Index with BRIC, we see it against its component indices. Despite the expansive discussion and coverage of “Chindia”, we find it’s Russia and Brazil that are the strong performers. Obviously, Russia is a big commodities play but Brazil is also commodity heavy. According to the iShares site for their Brazilian ETF (EWZ) the fund is roughly 25% in metals/mining and 25% in oil & gas.

Still, BRIC ETFs like the Claymore/BNY Bric ETF (EEB) in the US and the Claymore BRIC ETF [CBQ: TSX] in Canada, both of which track the BONY BRIC Index above, are not equally weighted by country. Both have the following country breakdown:

Brazil 45.88%

China 35.79%

India 13.56%

Russia 4.77%

You can see in EEM’s fact sheet (.pdf) that it has a 9.39% weight in Russia also as of December 31, 2006, nearly double the allocation in the BRIC ETFs. Yet despite this, EEM still underperforms the BRIC ETFs. Clearly the 18 other country exposures beyond the BRIC countries in EEM have an aggregate drag on return in relative terms. But in the bigger picture, we see that the divergence in performance is only significant in the past two years, but especially in the past six months.

The top five sectors are energy at 26%, 20% telecomm services, 19% financials, 14% materials and 9% IT. So, overall about a 40% commodity exposure and some decent sector diversification beyond that. No surprise then that the BRIC ETF tracks countries like Canada and Australia fairly well.

By the way, with regard to all the charts and data above, a big thanks to Som Seif of Claymore Investments here in Toronto.

It’s important to note that the indices mentioned in the above tables and charts are all from Bank of New York who is not a big name in indexing but who nonetheless has its own family of ETFS called BLDRS (Baskets of Listed Depositary Receipts). More info can be found on their site. I often mention EEM and VWO for emerging markets exposure, but I have been wrong not to include the BLDRS Emerging Markets 50 ADR Index Fund (ADRE):

This chart shows a slight outperformance of ADRE over EEM and VWO over this one year period but the ADRE factsheet (.pdf) from the BLDRS website shows that its benchmark actually trails the MSCI EM Index over the longer term. ADRE’s sector breakdown shows the same top five sectors as mentioned above but with an overall more diversified sector mix with less exposure to commodities.

With an underlying index of only 50 positions as opposed to EEM’s 275 holdings and VWO’s 862 holdings, you would expect greater volatility from ADRE. I would have expected more volatility than what is shown in the above chart. With a surprisingly low MER of 0.30% similar to VWO (unfortunately, the BRIC ETFs are both exactly double the cost at 0.60%), ADRE is an interesting choice for those who are willing to accept an even slightly higher level of risk, and thus potentially return.

Thus, ADRE nicely fits in between the (relatively speaking) low volatility EEM/VWO and higher volatility BRIC ETF as shown in this chart that only goes back as far as the inception date of EEB back in mid September:

Further to my closing comments on my previous piece specific to hedging strategies for emerging markets, if you’re looking to use these ETFs for opportunistic shorting during the relatively brief but often severe periods of distress, you may want to do some analysis on how their price movements compare historically. After the recent run (look at all the charts above and in my previous piece … many show them currently at highs), these positions as potential shorts could be truly spectacular, obviously if you get the timing right. For those with a more sensitive stomach, defensive posturing may be limited to simply reducing or outright selling positions if you, for some reason, lose your long-term orientation.

Hey, I just noticed one of my charts from the previous post, specifically the last one showing IFN and FXI. IFN looks now to be way down, in fact about 33% below its highs from May 2006. That looks a lot different from the light blue line for the BONY India Total Return Index which looks to be in a straight line up since roughly June 2006 in the second chart from the top above. Chalk up another one for the index.

So again back to basics: Not only is it difficult to choose a winning manager in the emerging market space (perhaps in the long only equity space overall?), but you also have to be right on the call among the various EM regions. For many, including the professionals, that can be tough. I’m all for having the choice to tilt EM regions and even countries like the BRIC components, but for most investors, a broader EM pick (EEM/VWO/ADRE) and/or a BRIC ETF should be sufficient exposure. Figuring in MERs and the costs of trading too many positions for what should be a rather small part of your portfolio, unless you really want a high vol program, one or two holdings is all you’ll really need.