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Thursday, March 28, 2013 - 14:30
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Thursday, March 28, 2013 - 14:30

Is This the Perfect Emerging Markets Portfolio?

Thursday, March 28, 2013 - 2:30pm

Although the previous decade heralded the arrival of the BRIC (Brazil, Russia, India and China) nations, the current decade has a new class of emerging markets favored by investors. In fact, those markets, which are also known by a handy acronym -- CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa), have outperformed the BRICs in recent years.

I looked at the CIVETS nations in the summer of 2010 and here is how they have performed since.

BRICs vs. CIVETS

(Market returns as measured by a leading country-specific ETF.)

At the time, I suggested investors steer clear of Egypt, and this portfolio would have gained 16% if Egypt were excluded, outperforming the BRICs by 23 percentage points or by nearly 10% on an annualized basis.

Forget emerging markets?
Yet in that time frame, the S&P 500 has gained a robust 49%. In effect, you would have been wise to simply ignore foreign markets during the past few years and save yourself a lot of trouble. But that's not the way this period should be viewed. Short-term phases of relative performance do not highlight long-term dynamics at play, as well as the opportunities for investors.

Yet the past few years have taught investors that these acronyms are helpful only to a point. The BRICs are substantial economies and hold more than roughly half of the world's population. The CIVETs can be seen as regional hubs -- countries such as Turkey and South Africa conduct a great deal of trade with their neighbors.

Yet these acronyms are not helpful in determining where to invest.

For example, Russia, Egypt and India are beset by so many problems that they carry too much risk. In any given year, these countries' stock markets can zoom ahead, but it's hard to see how they will outperform over the long haul.

Instead, focus on countries that are making the right moves when it comes to infrastructure development and middle-class nurturing. As I've written in the past, the theme of fast-growing middle classes in many emerging markets stands out as one of the top long-term investing angles, even if these markets have underperformed the S&P 500 in the past few years.

There will be bumps in the road. Vietnam and Turkey possess great futures, but their growth is hampered by inflationary bottlenecks. Colombia and Indonesia are examples of outstanding mid-sized markets that have all the attributes of sustainable long-term growth. Indonesia has done a good job of tackling endemic corruption, which is leading to solid gross domestic product (GDP) growth rates.

And Colombia is nearing the end of a brutal civil war. On a recent trip, I saw dozens of skyscrapers rising up across the country's top cities. It's hard to understate the powerful effect of Colombia's "peace dividend," though it is a bit troubling that the government and the rebels have not yet signed a final truce.

Blame it on Rio?
It's hard to pin down why Brazil, as measured by the iShares MSCI Brazil Capped Index (NYSE: EWZ) ETF, has fared so poorly, underperforming the S&P 500 by a stunning 62 percentage points since August 2010. To be sure, the Brazilian economy grew a tepid 2.7% in 2012 and is likely to grow less than 2% this year. This is an almost inevitable slowdown after years of solid growth.

Yet investors would be unwise to project Brazil's weak growth into the future. The country is blessed with a vast trove of natural resources, a fast-growing middle class, heavy (though belated) investments in infrastructure, and most importantly, vibrant growth with trading partners such as Chile, Colombia and Mexico. Brazilian tourists are among the most avid shoppers in many of the world's top cities, a sure sign of fiscal health.

In many respects, Brazil has the same characteristics that the United States had in the 1950s. In both instances, rising domestic consumption, productivity and trade set the stage for an extended economic expansion.

For perspective, the Brazilian ETF is back at levels seen in 2007. Since then, the Brazilian economy has grown from $1.4 trillion to $2.5 trillion. If market value-to-GDP is a worthwhile metric, then Brazilian stocks are a certifiable bargain.

Risks to Consider: These emerging markets have lagged behind the United States, although a pullback in U.S. stocks would create a headwind for these markets. That underpins the notion that these markets are best viewed as long-term holdings.

Action to Take --> The BRICs and the CIVETS hold valuable markets. Leaving aside China, which possesses great long-term upside with perhaps near-term indigestion, let's focus on the best of these acronyms. In my opinion, they are Brazil, Turkey, Vietnam, Indonesia and Colombia.

Indeed, this is the perfect emerging markets portfolio (though you could easily substitute countries such as Thailand for Indonesia, or Mexico for Colombia). Each country possesses robust long-term growth prospects, and as each market has underperformed the United States since then, it's time to give them fresh attention.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.