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The buck stopsmarkets

Are emerging here:

Vanguard money
still built on market funds
the BRICS?

Vanguard Commentary May 2016

Jonathan Lemco, Ph.D.

Since the early 2000s, the BRICS countries (Brazil, Russia, India, China, and, later,
South Africa) have been among the fastest-growing economies in the world. In 2001,
these five nations comprised about 9% of global gross domestic product (GDP). By 2016,
that percentage was approximately 25% of GDP, and the five countries accounted for
41.4% of the worlds population.

But many of the BRICS ambitious goals have gone unrealized thus far. In fact, many
observers assert that what divides the BRICS (geography, disparate interests, and internal
rivalries) has proven much more pervasive than what unites them.

Perhaps it would be most useful for investors to consider the BRICS not as an economic
bloc but as a group of five major developing economies with certain common interests.

Acknowledgment: The author thanks Matthew C. Tufano, of Vanguard Investment Strategy Group, for his
significant contributions to this paper.
The term BRICS is commonly used to refer to the most Since the early 2000s, the BRICS (and other large
prominent emerging market countries. There wasand emerging market countries, including Malaysia, Mexico,
isa presumption that there is something relevant about and Indonesia) have been among the fastest-growing
grouping them together for investors. By contrast, we economies in the world. In 2001, the five BRICS nations
argue that the term was never intended to be more than comprised about 9% of global GDP. By 2016, that
a useful acronym. In fact, what distinguishes the BRICS percentage was approximately 25% of GDP, and the
countries from one another is much greater than their five countries accounted for 41.4 percent of the worlds
common characteristics. population. Varying levels of prosperity and influence
on the world stage have accompanied this rapid growth.
BRICS emerged from a 2001 report titled Building Advocates for the BRICS assert that these countries
Better Global Economic BRICs by Jim ONeill of share certain common interests and could thrive with
Goldman Sachs Asset Management. At first, the reference increased cooperation on trade, investment, and political
was synonymous with the four largest emerging markets. goals. Despite their rapid growth this century, it should
It was meant to convey a new era in which the countries be noted that between 2010 and 2015, the BRICS and
were experiencing new challenges and new opportunities the other prominent emerging market countries have
in the world economy. Indeed, ONeill suggested that in demonstrated slowing growth, as shown in Figure 1.
the coming years, these rapidly emerging nations would
be the strategic pillars of a renewed international system. The BRICS countries are among the largest on their
The more wide-eyed optimists among the BRICS continents and could best represent the priorities of
advocates speculated that these large emerging market their regions. The symbolism of these five nations
nations would represent all developing countries and finding common purpose is an inspiring thing. Further,
would promote a more legitimate, representative, and there has been an understanding by BRICS proponents
fair international order. that these large economies, if working together, could
pose a meaningful challenge to the United States and
But in 2001, this BRICS idea was just an acronym in Europes dominance over international affairs. The BRICS,
a research report. Soon after the reports release, the especially China and Russia, could demand and expect
financial press picked up on the idea, and the term took to receive a place at the table regarding economic
on a life of its own. The nations met formally in Russia and political decision-making.
at the inaugural BRICS summit in 2009. South Africa
officially joined in 2011. What was once just a useful tool But many of the BRICS countries ambitious goals
to describe first four and then five of the most important have gone unrealized thus far. In fact, many observers
emerging market nations had morphed into a forum assert that what divides the BRICS (geography, disparate
for expressing common interests and concerns. interests, and internal rivalries) has proven much more

Notes on risk

Investments are subject to market risk, including the possible loss of the money you invest. Past performance is no
guarantee of future returns. Investments in stocks issued by non-U.S. companies are subject to risks including country/
exchange rates. Stocks of companies based in emerging markets are subject to national and regional political and

Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility. Prices of mid-
and small-cap stocks often fluctuate more than those of large-company stocks. Diversification does not ensure a profit
or protect against a loss in a declining market.

Figure 1. Growth in the BRICS and other prominent emerging market countries has slowed,
with some faring worse than others

Real GDP Russian South

annual growth Brazil Federation India China Africa Indonesia Malaysia Mexico

3.39% 1.38% 4.05% 9.20% 2.65% 4.70% 7.33% 6.96%


7.57% 4.50% 10.26% 10.60% 3.04% 6.38% 7.53% 5.11%


3.03% 3.83% 7.26% 6.81% 1.40% 4.66% 4.70% 2.31%

Weak Strong

Note: Based on 2015 data.

Sources: Vanguard, based on data from International Monetary Fund (IMF) and Moodys Analytics.

pervasive than what unites them. Further, their common development institutions. For Russia, which is hampered
influence, particularly within the United Nations and by western-imposed sanctions, the NDB is a way to
other international bodies, has proven limited. It is one exert lost influence on the world stage. If the bank is
thing to identify five regional economic powerhouses. successful, the argument goes, then emerging markets
It is another to presume that they could easily form a worldwide would benefit, and that is all to the good.
meaningful multilateral bloc. Critics charge that the notion But the NDB, with an initial capitalization of $100 billion,
of a common BRICS purpose seems contrived, as each is still in its infancy.
nation is so different economically and politically. Thus
far, there is not much of a collective identity and only We would also note that although the term BRICS was
the beginning of an institutional apparatus. There is no useful to describe the largest emerging markets in 2001,
strategic BRICS agenda that would include their concrete it might not be as relevant today. Why should such
goals. In fact, the countries share no coherent foreign emerging market powerhouses as Indonesia (the fourth
policy objectives and interests. most populous nation in the world), Turkey, South Korea,
Mexico, and possibly Saudi Arabia be excluded? From
Indeed, with one exception, it is hard to find tangible an investment perspective, these countries are active
evidence that the promise of BRICS unity on inter- issuers in the international debt capital markets. This
national issues has produced much of substance. is one reason investors focus on them, as they do the
The exception is the serious conversation about New BRICS. All of these countries have gained much influence
Development Bank (NDB) BRICS, which was launched globally in the last 15 years. Drawing the line between
in Shanghai in July 2015 to provide an alternative to the five BRICS and these other prominent emerging
the U.S.- and European-dominated World Bank and market nations is now less meaningful.
International Monetary Fund. The NDBs mandate is
to efficiently channel savings into infrastructure and One motive for the creation of a BRICS alliance was the
sustainable development. From Chinas perspective, idea that only a unified grouping of the largest emerging
the NDB provides an alternative to western-dominated market countries could counterbalance the perceived

hegemony of the United States and, to a lesser degree, South Africa will remain investment grade with all of the
Europe. But in the real world, one might acknowledge agencies for now, but it is also a deteriorating credit due
that each of the BRICS has a varying relationship with to its sub-par political and macroeconomic management.
the United States. For example, Russias trading and
investment relationship with the United States and Europe As of 2016, the BRICS countries are facing domestic
is modest, and its economic and strategic interests clearly challenges that may distract their policy-makers from
compete with the wests. But Chinas economy is notions of emerging market unity. Brazil is in the midst
co-dependent with that of the United States and Europe. of the worst political scandal in modern Latin American
Its strategic interests differ from those of the United history, the Lava Jato (Car Wash) Affair. Numerous
States, but China and the west also complement each public sector officials in the federal government and
other in many ways. Also, India, Brazil, and South Africa the government-owned Petrobras national petroleum
often disagree with the United States on selected company have been implicated. As a consequence,
economic interests. But overall, their economic, political, the process of impeaching Brazilian President Dilma
and strategic priorities are usually aligned with those Rousseff has begun.
of their western counterparts.
Russia is dealing with crippling international sanctions,
Until 2014, the BRICS countries were among the fastest a GDP that has fallen 3.7% in the first quarter of 2016,
growing countries in the world. They demonstrated and plummeting oil prices. South Africas mining sector
adequate fiscal prudence (as shown in Figure 2) and is in disarray, the credibility of its Finance Ministry is in
reasonably solid monetary policy, such that they were serious question, and the governments policy proposals
considered investment grade with at least two of the appear more arbitrary each day.
three most prominent credit rating agencies (Moodys,
Standard and Poors, and Fitch Ratings). But as of In India, Prime Minister Narendra Modi has proposed
May 2016, Russia remains split-rated (partly investment the most wide-ranging set of economic reform proposals
grade and partly junk-rated) and declining. Brazil is now in the nations modern history, but their implementation
junk-rated with all three of the credit rating agencies. is proving problematic. China President Xi Jinpings

Figure 2. BRICS and other major emerging markets economic and fiscal fundamentals are mixed

Russian South
Brazil Federation India China Africa Indonesia Malaysia Mexico

debt/GDP (%)
8.50% 8.91% 1.43% 0.69% 10.38% 8.28% 13.95% 18.03%
GDP (%) 19.68% 25.88% 15.32% 29.38% 13.12% 11.83% 29.98% 14.93%

Fiscal surplus/
deficit as
% of GDP
7.67% 5.68% 7.20% 1.92% 4.07% 2.33% 3.51% 4.00%

Weak Strong

Notes: Foreign-exchange reserves, GDP data, and fiscal balance as of end of 2015; international debt as of second-quarter 2015 (latest value reported).
Sources: Vanguard, based on data from Bank for International Settlements; IMF databases (International Financial Statistics, Fiscal Monitor, and World Economic Outlook);
and Moodys Analytics.

proposed numerous economic and political reforms are If there was a hope in 2001 that the BRICS would
proceeding; however, implementation of these reforms eventually demonstrate a measure of cohesion based
will take years in some cases. But Chinas economic on common interests, it has not yet occurred in a serious
growth continues to slow, and private sector debt is way. The countries quarrel among themselves as much
increasing rapidly. For quite some time, the government as they take issue with more developed market countries.
has been constrained by a burgeoning credit bubble in an Perhaps it would be most useful for investors to consider
economy that is growing at its slowest pace in 25 years. the BRICS as something less than an economic bloc and
To those who suggest that political freedom and economic instead as a group of five major developing economies
growth should be correlated, the evidence, as noted in with certain common interests. Beyond the notion that
Figure 3, is not conclusive. they pose an alternative to western-dominated institutions,
the BRICS have growing needs for trade and investment,
In short, the five BRICS countries are at middling stages for new and effective development assistance strategies,
of development, with all of the accompanying stresses. and for political reform opportunities. The BRICS are not
All of the BRICS are experiencing demographic challenges. a uniform bloc but are instead an ever-evolving and
All are witnessing slowing economic growth and rapidly powerful group of voices on the international stage.
increasing economic inequality. All need far more private
sector investment. All require more respect for property
rights and the rule of law. The commodity producers Reference
are seeing plummeting prices for oil, copper, and other ONeill, Jim, 2001. Building Better Global Economics BRICs.
commodities, and world trade is not nearly as robust as Global Economics Paper No. 66. New York: Goldman Sachs.
it was in 2010. Perhaps most important in 2016, all of
the BRICS have growing public and private sector debt
burdens, forcing higher borrowing costs.

Figure 3. There is no strong correlation between political freedom and economic growth

Russian South
Brazil Federation India China Africa Indonesia Malaysia Mexico

Freedom in
the World
status, 2016 Free Not Free Free Not Free Free Partially Partially Partially
Free Free Free

Source: Vanguard, based on data from Freedom House.

Appendix. No correlation between economic growth and real equity returns
Forming an investment case based on the BRICS growth and real equity returns; holding the BRICS
economic fundamentals would not have yielded fruitful as a group offers no advantage relative to the broad
results. Previous Vanguard research has shown that class of emerging markets.
there is virtually no correlation between economic

Figure A-1. Allure of high-growth economies does not usually lead to high-return performance

Real GDP growth and real stock returns 19702015

15% Mexico
real equity market return

10 South Africa
United States R 2 = 0.0267
Average annual

5 Germany India China


10 Russia

0% 1 2 3 4 5 6 7 8 9 10%
Average annualized real GDP growth

Emerging markets
Peripheral Europe
Core Europe
Developed markets

Notes: Figures display each countrys average annualized real GDP growth rate and average annualized real stock return. We include all members of the FTSE All World
Index (except the United Arab Emirates, for a lack of return history). The period covered begins in 1970, with the starting point for each country depending on the availability
of both returns and GDP data. (Most developed markets have data from 1970 onward, and most emerging markets have data from 1988 onward.) Real growth rates are
computed using data from the IMFs World Economic Outlook database. (For data prior to 1980, we use the April 2004 database; otherwise, we use the April 2013 database.)
Return data are based on MSCI country indexes spliced with FTSE indexes once the latter are available. Both growth and return data are in real local terms, with the index
returns deflated using the GDP deflator from the IMF databases.
Sources: Vanguard, based on data from the IMF, MSCI, and FTSE.

Figure A-2. Relative strengths and weaknesses of the BRICS

Russian South
Brazil Federation India China Africa

Strengths A bundant natural Military superpower. A mbitious reform Positive momentum A bundant natural
resources. Well-educated labor agenda. in adopting structural resources.
L arge population. force. L argest democracy reforms. Most economically
Nuclear power. in the world. Economic power. developed large
nation in Africa.

Weaknesses Currently engulfed L ack of industrial Slow progress in Mixed results in Deteriorating fiscal
in political scandal. diversification. adopting reform. passing structural and economic
Weak educational Too much Weak infrastructure. reforms. situation.
institutions. dependence on Unpredictable Nondemocratic Weak political
petroleum reserves. corruption. character of management.
Growing private
sector debt

Source: Vanguard.

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