Prior to the GFC there was a school of thought that the BRICs could lead the way for equity markets irrespective of the economic conditions being experienced by the rest of the world and in particular the developed economies.
But the BRICs too felt the pain of the GFC, especially when developed markets were at their lowest points in 2008. During this period investors fled back to the developed economies in order to minimise risk.
"In 2008 we saw a massive risk-aversion trade, but it was probably not dissimilar to what happened across all asset classes. We certainly saw in emerging markets people gravitating back towards US treasuries, but it wasn't like a switch out of developing equities into developed equities. It was more a move from risky assets into less risky assets," Rare Infrastructure emerging markets portfolio manager Charles Hamieh says.
However, evidence of this move back to developed economies is still present as volatility continues to be a recognisable characteristic of the global recovery to date.
"In these recent few weeks where we've seen a lot more volatility in the markets certainly there has been some pressure on emerging markets partly due to that risk aversion, partly due to the amount of liquidity that flowed into emerging markets in 2009, and partly due to a bit of profit taking as well," Aberdeen Asset Management senior investment specialist Stuart James says.
Of the BRICs, Russia in particular experienced a tough time in 2008.
"Russia took a big knock in 2008 as commodity prices collapsed and the rouble fell. At that time the domestic market was down about 66 per cent," East Capital chief executive Michael Hanson-Lawson says.
What happened in 2008 may have provided some justification to feel the BRICs were just a passing fad that were not the great hope for the future of equity markets. However, events subsequent to the GFC have shown the BRICs as a good investment story remains.
"Global equity funds, that began the year underweight emerging markets by 210 basis points versus the benchmark weighting, have reduced their underweight to only 70 basis points currently. Meanwhile, at the retail level, data collated by EPFR shows cumulative inflows to emerging market equity funds of US$91 billion since January 2009 versus outflows of US$71 billion from developed market equity funds over the same period," Hamieh says.
Like Hamieh, Templeton Emerging Markets Group executive chair Mark Mobius feels the strength and attraction of emerging markets is continuing.
"In the first 11 months of 2009, emerging markets recorded nearly US$75 billion in net inflows, nearly 40 per cent more than the record-high US$54 billion of net inflows in 2007. This year has proved that emerging market stocks have outperformed developed markets and this is likely to continue," Mobius says.
The strength of the BRICs has been the economic growth they have been experiencing in recent times. However, these growth rates were dented at the height of the GFC as International Monetary Fund (IMF) data released in April this year has shown, with Brazil generating gross domestic product (GDP) growth of -0.19 per cent in 2009, India 5.67 per cent and China 8.74 per cent.
Even though these growth rates were down on previous years, relative to the developed world they were still pretty good.
"Everyone did it tough in the dark days of the GFC, but in comparison to their developed colleagues the developing economies were in far more attractive positions, and so they've sharply rebounded and in comparison their economies look far more attractive to the large deficits and anaemic growth that is prevalent in the US and Europe," Lonsec senior investment analyst for managed funds research Steven Sweeney says.
The IMF forecasts would also seem to reflect that to these three BRIC economies the GFC was only a minor setback with strong positive GDP growth expected again for the next few years. The anticipated GDP growth in 2010, 2011 and 2012 for Brazil is 5.5 per cent, 4.1 per cent and 4.1 per cent respectively. Similarly for these respective years India is predicted to generate GDP growth rates of 8.8 per cent, 8.4 per cent and 8 per cent, while China is forecast to experience growth of 10 per cent, 9.9 per cent and 9.8 per cent.
Russia, along with the other eastern European countries, has also managed to get back on its feet relatively quickly after a tough time during the global downturn. Mobius says it was actually one of the hardest hit by the crisis but the worst is definitely over.
"Oil prices plummeted and rating agencies lowered their credit ratings on several Russian banks, while the country's GDP shrunk by 7.9 per cent in 2009 and stock prices plunged significantly from their peak. The government had to recapitalise the banking system and bail out several large state companies, thus putting further pressure on its own finances," he explains.
"However, we believe the worst is over. We have already seen a sharp recovery for Russia's GDP growth recently when commodity prices stabilised. Russian oil supply experienced significant growth in 2009, which took most forecasters by surprise. The International Monetary Fund is even more optimistic about Russia's growth, expecting its economy to grow by 4.3 per cent in 2010, due to rising oil prices and an improving fiscal outlook."
Hanson-Lawson agrees eastern Europe, including Russia, dealt with the GFC effectively and had come through the other side in good shape.
"Eastern Europe from all of these dire prognoses we had 18 months ago, in fact managed the crisis quite well. And the three biggest countries, Russia, Turkey and Poland, didn't require any outside help at all. They all had their own stimulus programs and they all are now in positive territory in terms of GDP growth this year," he says.
While it would seem the evidence points to a rapid return to strong economic growth for the BRICs, does this necessarily translate into good equity market returns for investors? Sartori says it does but the time horizon the investor employs is a critical factor.
"Most historical academic studies would say that there's not a strong correlation between strong economic growth and stock market performance in the short to medium term. But I think over the very long term then that correlation becomes much stronger," he says.
"So over the next six to 12 months stock prices may not correlate with what their domestic economic growth is doing, but over the next five to 10 years there's a much stronger case for that."
Hamieh agrees that investors looking for a link between the two factors over the short term may be disappointed, but those who are prepared to adopt a longer time line will see some stock market rewards.
"It doesn't always translate. We've seen China underperform global markets terribly in the last six months, but you'd hope with an investment horizon of five years plus there will be an alignment between the state of the economy and equity markets," he says.
Even though the BRIC economies have rebounded very quickly since the GFC it was evident during the bad times they were not completely bulletproof from what was happening in the rest of the world. This was largely driven by the underlying characteristics of each of the economies, with Brazil, Russia and China more dependent on exports.
But in the aftermath of the GFC there are still a number of stimulus packages in the wider global economy, and in particular the US, that are yet to play out. So will some of the BRICs still suffer the adverse effects of the eventual withdrawal of these fiscal policies?
"If you take away stimulus in the US right now you have to ask yourself is the private sector healthy enough at the present to pick up the slack and I have some doubts that is the case. Therefore I think we might see economic growth in the second half of the year in the US to fall below market expectations," James says.
"The knock-on impact of that is potential double dip recession, certainly a change of sentiment, less demand from the US consumer, and that will certainly have a knock-on effect on emerging markets.
"But I'd imagine that knock-on effect would be to trim growth from 6 or 7 per cent possibly down to 4 or 5 per cent, so I can't see it being catastrophic for emerging markets."
However, according to James, this presents a good opportunity for emerging markets to put more emphasis on domestic demand. To do so emerging markets will have to stop protecting their currencies and allow them to appreciate, a move that will in turn make imports cheaper, which will in turn stimulate domestic demand.
Fiducian Portfolio Services investment analyst Jai Singh says India's greater reliance on domestic demand makes it less vulnerable to developed market influences than its BRIC counterparts.
"It's important to remember many of the emerging markets are export driven and when these countries and developed nations start to suffer or their consumers become benign, a lot of the growth factored in previously might not be there," he says.
"Then it comes back to seeking which asset classes are unique that can withstand that kind of dynamic and actually provide a differentiation in a client's portfolio, and I'd have to say in this context the India story is a good one."
Looking to make their economies more domestically driven is one way to combat the BRIC economies' exposure to developed market conditions but so too is increasing their trading links to other emerging markets. According to Mobius, this is already starting to happen.
"The BRIC and other emerging markets are becoming more interdependent and we expect this to continue into the future. For example, the percentage of exports going to Europe and the US from emerging markets has declined. Now China, rather than the US or Europe, is the largest trading partner for most Asian countries," he says.
"For example, around 20 per cent of South Korean exports were going to the US in 2003, but that figure has now come down to around 11 to 12 per cent. In contrast, the percentage of South Korean exports to the rest of Asia has now surpassed 50 per cent, primarily because of demand from China and India. Essentially, many east Asian countries are benefiting from strong economic growth in China and India."
Singh agrees these initiatives are already underway but so far have not been well publicised.
"There's a lot of trade that happens between them that goes unnoticed. I think it goes back to relationships that countries like Russia, China and India have had with each other for hundreds of years. I think over time as the wealth effect takes place there will be more scope for each of those countries to work together," he says.
So despite the GFC and its continuing effects, the BRICs are still offering strong economic growth and good investment opportunities. However, perception is still a very powerful element and without investor confidence positive characteristics mean very little. As such, to determine the potential success of these regions as investment sweet spots one must find out what the investors' approaches to the BRICs are.
Mobius believes investors are still a little suspicious about these economies but the situation is definitely improving.
"Generally speaking, investors around the world are underweight emerging markets including BRICs, however, we do believe that investors are becoming more open and comfortable with the idea of investing in emerging markets. As mentioned above, emerging markets recorded nearly US$75 billion in net inflows, nearly 40 per cent more than the record-high US$54 billion of net inflows in 2007," he says.
"On average, investors have a weighting of approximately 3 to 8 per cent toward emerging markets in their portfolios, while emerging markets now represent about 30 per cent of the global market capitalisation. This leads us to believe that the potential demand for emerging markets is likely to be significant."
James says investors are still nervous in general and that sentiment has not helped them to improve their perceptions that other markets offer less risk than the BRICs.
"Emerging markets are still perceived to be riskier than the developed economies. I would argue that the gap between emerging markets and developed markets is closing all the time. Some people don't like the emerging markets because they perceive there is too much political risk, but in reality there is political risk everywhere," he says.
Unlike some of the other BRICs, namely India and China, Hanson-Lawson believes Russia has an image problem to overcome with investors.
"If you look back 15 years ago, China had an image problem. Back then China was bad but these days everything China does is fantastic. So it's changed its image and that's taken some time as I think it will with Russia," he explains.
"I think Russia gets a pretty rough deal from the press. I think with any stories there are usually two sides and with Russia we usually get told about the negative side rather than the positive side. I think the Russians are aware of this image problem and they are trying to polish it up."
The GFC provided a good stress test for the BRICs, along the way dispelling a few economic theories, in particular decoupling from what was going on in the developed world. Some of these theories were the justification for the belief the BRICs were the new frontier that would drive the investment world forward and into the future. With all that has happened, does this positive view of the BRICs still ring true?
"We can still look to emerging markets as the new driving force of the investment markets globally. The rapid developments in emerging markets should allow these markets to command even greater attention in the global investment universe. In our opinion, emerging markets such as China, Brazil and India could eventually become some of the world's most important and influential countries," Mobius says.
Sweeney agrees the BRICs and other emerging markets can continue to be seen as the new driving force for investors and feels there is already evidence of it happening.
"It's a pretty rare dissenting voice among the investment community that does not expect emerging markets to do most of the heavy lifting in terms of global growth," he says.
"We've certainly seen the majority of our global large-cap managers look to increase their allocations to emerging markets in the last 18 months or so. Our house view is that there is a pretty compelling case to allocate to emerging markets as a means to enhance the returns from global equities."
Like his peers, Sartori is also convinced the BRIC and emerging markets will lead the way for investors in the future.
"I'm a firm believer that over the medium to long term economic and also financial markets leadership will switch from developed into emerging markets. Everyone spoke about decoupling and so forth before the financial crisis, and from a stock market point of view it absolutely did not happen, and now most people have given up on it. But I think it will begin to happen going forward," he says.
