Goldman strategy is full of potential pitfalls

Goldman strategy is full of potential pitfalls
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First Published: Tue, Jan 08 2008. 12 20 AM IST
Updated: Tue, Jan 08 2008. 12 20 AM IST
Certain investment ideas hit you right in the heart. Your pulse races because they seem so obvious, so immune to failure.
Last year’s source of investor palpitation was a Bric strategy, a solid-sounding acronym that targets only Brazil, Russia, India and China.
In a year when the US and European markets were blindsided by the perils of a credit crunch, high-risk, mortgage-backed securities and a housing recession, common stocks in developing countries were robust engines of growth.
Behind this enticing thought, though, are risks that haven’t surfaced yet. And these markets may not repeat their stellar performance in 2008. There are many other ways of tapping emerging market growth that might be better long-terminvestments.
At first blush, the Bric idea seems like a firm foundation for a growth portfolio. In the three months through 30 September, Brazil’s gross domestic product (GDP) expanded 5.7%; Russia at 7.6%; India at 8.9%; and China was up 11.5%.
Growing economies are typically good for companies based in those countries. That’s the rationale behind a new generation of mutual and exchange-traded funds. The Bric strategy was inspired by a paper published by Goldman Sachs Group Inc. in 2003.
Bric growth
Titled Dreaming with Brics: The path to 2050, the report predicted that in less than 40 years, the combined economies of these high growth countries would be larger than that of the top six nations today in US dollar terms.
“About two-thirds of the increase in the US dollar GDP from the Brics should come from higher real growth,” it stated, “with the balance through currency appreciation. The Brics’ real exchange rates could appreciate by up to 300% over the next 50 years.”
Combined with the dollar losing ground against most major currencies in recent years, moving into the Bric camp became even more profitable. It all looks promising—until you look at the downside.When you enter the highly focused Bric world, you need to understand some of the special risks.
By concentrating on the most vibrant economies in the world, you are increasing the volatility of your portfolio. Yes, you counter, but what are the odds of four large countries simultaneously experiencing stock market swoons? Would they all move in lockstep?
China bubble
A bubble bursting in China would hit world markets at the speed of light. China’s CSI 300 Index, a basket of stocks on the Shanghai and Shenzhen exchanges, rose about 160% last year. Many analysts say it’s ripe for a decline.
Rapid growth often invites rampant stock market speculation. Remember the Asian “contagion” crisis of 1997?
As evidenced in the past, a massive sell-off by institutional traders can take down all emerging markets.
It’s not hard to find a hot performer in the Bric stable, which includes more than 10 funds. Based on recent returns, the Claymore/BNY Bric exchange- traded fund posted a performance not seen in the US since 1999. It rose 67% in the past year. Once you do some risk analysis, though, you can see red flags.
If you expected equal weighting among the four countries represented in the Claymore fund, you will be disappointed. Like most funds, its managers are guessing how each country and their securities should be balanced.
Concentrated risk
With more than 80% of the fund invested in Brazil and China, the fund’s focus is concentrated in two economies.
There’s no reason to boost your portfolio risk—and miss returns elsewhere—if you don’t have to. Alternatives are available. There’s a better way of capturing international growth while lowering volatility.
A better vehicle for diversification is a fund that invests in Europe, Australia and the Far East, also known as EAFE. The iShares MSCI EAFE exchange-traded fund, for example, is a reasonable way of tapping global returns without loading up on any one country.
While gaining less than 10% last year, it has outpaced the S&P 500 Index by 77 percentage points over the past half-decade. Mature economies are mixed in with emerging markets in the iShares fund, translating into about half as much downside risk and volatility as the Claymore fund and providing an extra layer of insulation when the Bric markets turn south.
This year, you may see even stronger returns from developing countries. Don’t give in to the hype of the concentrated vehicles that bulk up on them, though. This year’s miracle performance is often tomorrow’s heartbreak.
John F. Wasik, author of The Merchant of Power, is a Bloomberg News columnist. The opinions expressed are his own.
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First Published: Tue, Jan 08 2008. 12 20 AM IST
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