One investment theme trumped all in the first decade after the millennium, as China and emerging markets powered ahead and played catch-up with the rest of the world.
Everybody was talking about the BRICs, the acronym coined by Goldman Sachs chief economist Jim O’Neill in 2001 for Brazil, Russia, India and China, four sleeping giants that were finally bursting into life.
Investors made fortunes but this did not last. Vijay Valecha, chief investment officer at Century Financial in Dubai, says the excitement faded after the financial crisis, with China and emerging markets dramatically underperforming over the past decade.
The iShares MSCI Emerging Markets Index has delivered a disappointing average annual return of just 3.27 per cent over the past 10 years, way behind the 9.95 per cent average annual growth of the MSCI World Index.
Brazil was too dependent on commodity exports and suffered as the US dollar strengthened, commodity prices rose and demand fell.
The global oil price slump affected Russia, along with western sanctions.
India has fared better, and its economy has been boosted by Prime Minister Narendra Modi’s reforms since his 2019 election victory.
Chinese growth is now largely driven by debt, with total government, corporate and household borrowing surging to an incredible 317 per cent of gross domestic product.
Investors have turned their attention back to the world’s biggest economy, where US technology companies Facebook, Amazon, Apple, Netflix, Google-owner Alphabet and Microsoft have replaced the BRICs as the investment story of the decade.
Mr Valecha says the USA MSCI Index has grown by a far more rewarding average rate of 14.09 per cent a year, while the tech-dominated Nasdaq 100 has delivered an astonishing 9.32 per cent a year.
However, he believes this trend could now begin to reverse, with both the US stock market and US dollar looking overpriced.
China was the first country to be hit by the Covid-19 pandemic, and it now appears that it will be the first out of it. The latest data shows it returned to growth in the second quarter, although domestic consumption and investment were weak.
GDP grew by 3.2 per cent, beating consensus estimates of 2.4 per cent, despite falling retail sales and business investment. This comes after a sharp drop of 6.8 per cent in the first quarter.
Eng Teck Tan, senior portfolio manager at Nikko Asset Management, says if China can avoid a full-blown second Covid-19 wave, it can be the first major economy to bounce back.
It still faces major challenges though, including rising bankruptcies and unemployment, and the trade war with the US.
Despite this, Mr Tan says the Chinese technology sector could outperform market forecasts, as digitalisation accelerates after the pandemic.
“China may even emerge stronger, given the rise of its high-tech and digital economy-related industries.”
Mr Valecha says China’s manufacturing sector is plagued by overcapacity and will probably be affected by the trend of deglobalisation, as companies bring crucial industries and global supply chains back home.
He suggests looking for Chinese companies that will benefit from growing domestic consumption to offset any slump in exports as the world falls into recession.
“Chinese consumers could drive further growth at e-commerce giants Alibaba and JD.com, and web conglomerate Tencent Holdings,” he says.
As the West pulls back from China, Mr Valecha says India could be the beneficiary. Its companies have been through a painful process of reducing debt and cleaning up their balance sheets but have enjoyed some success.
“Indian stocks now look cheap in US dollar terms. A combination of export-focused and domestic consumption will be great for the investor,” he says.
However, the pandemic is hitting India hard. The country recently overtook Russia and now has the world’s third-highest number of infections.
Invesco’s chief global market strategist Kristina Hooper says the lockdown has exacted a “severe economic toll”, and this has forced Indian authorities to reopen its economy, “even as the pandemic curve seems to be steepening rather than flattening”.
However, she praises Mr Modi’s reforms, saying this could boost foreign direct investment and capital expenditure.
“The reform process may prove slow and insufficient, in which case India’s recovery could well disappoint.”
Coronavirus is “running rampant” in Brazil, which has the world’s second-highest number of infections.
Ms Hooper says the recovery hinges on successful containment. It then needs “a sustainable recovery in the global economy that helps boost commodity export prices and volumes”.
Russia has the fourth-highest number of infections but Maria Szczesna, co-manager of Baring Emerging Europe, says there may be opportunities in the country’s technology sector.
She highlights X5 Retail Group, whose online food delivery business has benefited from the pandemic, and online-only bank Tinkoff, a fast-growing FinTech star with 13 million customers.
Ms Szczesna says Russian companies offer some of the world’s most generous dividend yields for investors seeking income.
“Major Russian companies, such as energy giants Lukoil and Gazprom, and financial services companies Sberbank and X5, are committed to paying dividends, having taken major steps to improve their financial and ownership transparency,” she says.
Fabian Chui, global head of the front office at Abu Dhabi-based financial services company ADSS, says while monetary stimulus has stabilised financial markets, the long-term global outlook remains uncertain.
Further volatility could offer a buying opportunity for the BRICs, but he says they have diverged massively since first being identified, with China and India outdoing Brazil and Russia in performance.
Mr Chui says China remains the most tempting today.
“It has strong fundamentals and is in a good position to adapt to new global economic realities.”
It also looks to have dealt with the pandemic better than most.
“Despite the global risks ahead, clients should still be positioned to have decent exposure to the Chinese economy,” he says.
A globally diversified portfolio should always make space for emerging markets, although most investors should limit this to 10 to 20 per cent of their total holdings, depending on their attitude to risk.
Buying individual stocks is too risky for most, but you can have broad-based exposure through a low-cost exchange traded fund.
You could spread your risk by investing across a range of countries through, for example, the Vanguard FTSE Emerging Markets ETF or the iShares Core MSCI Emerging Markets ETF.
These funds have different levels of exposure to various emerging market countries. For example, a third of the Vanguard fund invests via Hong Kong, with roughly 15 per cent in Taiwan, about 10 per cent in India and China, and less than 5 per cent in Brazil and South Africa.
Alternatively, there are a host of individual country ETFs such as the iShares range-tracking MSCI indices for China, India, Brazil and Russia.
Before investing, check how much exposure you already have to this theme.
The BRICs as a concept was always more of a marketing tool, which involved lumping together very different economies under the same banner.
Every hot investment theme cools in the end. The same applies here.
Serious investors cannot ignore emerging markets, nor should they be too excited. All of them face major challenges.
As always, only invest for the long-term because the short-term will be sticky. Especially with the pandemic still raging.
