Russia is the Most Attractively Valued BRIC Market

From time to time, Morningstar publishes content from asset managers, educational institutions, and registered investment advisers under our "Perspectives" banner. If you are interested in Morningstar featuring your content, please contact Online Editor Holly Cook at holly.cook@morningstar.com. Here, HSBC Global Asset Management says Russia is the most attractively valued BRIC market but all should continue to prosper from strong domestic consumption.

Strong domestic consumption in Brazil, Russia, India and China (BRIC) is a key driver of continued strength in these markets according to HSBC Global Asset Management, one of the world’s largest investors in this asset class with more than $28 billion BRIC assets under management. (1)

Nick Timberlake, Head of Emerging Market Equities at HSBC Global Asset Management and lead manager of the HSBC GIF BRIC Equity Fund, said whilst high debt levels would remain a drag on developed world growth for many years, key emerging economies now have the financial fire power to mitigate the effects of lower export growth through home grown consumption.

He argues that a rising middle class combined with low penetration and pent up demand for goods such as computers, mobile phones and automobiles, has unleashed strong internal demand within these markets.

“Amid a population of 2.7 billion people in the BRIC markets, representing approximately 40% of the world’s population, rising affluence is fuelling growing demand for goods. Domestic consumption is also a key driver of intra-BRIC market trade. The BRIC markets are no longer as heavily dependent on the developed world. For example, Brazil’s biggest trading partner is no longer the US but China,” Timberlake said.

Philip Poole, Global Head of Macro and Investment Strategy at HSBC Global Asset Management, added that strong domestic consumption is imperative in order for emerging markets to sustain a healthy growth differential relative to the developed world. “The good news is that we already have evidence of this and economic policies in markets such as China are increasingly focussed on supporting domestic consumption growth.”

HSBC Global Asset Management believes that following a correction within BRIC markets, valuations are now back at fair levels, with current prices presenting a good entry opportunity for investors with a long-term investment horizon.

Russia

Russia, currently the HSBC GIF BRIC Equity fund’s largest overweight position, is unloved and undervalued by the market at present, with the stock market trading at just 5x 2011 price earnings. However, with valuations expected to revert in due course, and with the fundamentals remaining sound, the opportunity for upside looks favourable, according to Ed Conroy, co-manager of the HSBC GIF Russia Equity fund.

Furthermore, prospects are enhanced by the supportive long-term investment case, as evidenced by low levels of government and personal leverage, rising investment levels and an abundance of natural resources.

Although better known for its oil production, Russia also has a particularly compelling story in terms of domestic consumption. Conroy pointed to a seven fold increase in Russian US dollar wages between 1999 and 2008. This has triggered a retail boom in Russia, which by global standards is still in its infancy. As a result, there remains an abundance of growth opportunities for manufacturers and retailers alike. To support this, evidence shows that consumer spending has been more resilient than the broader economy during the recent turmoil.

China

In China, thriving domestic consumption is being driven by numerous factors, not least rising urbanisation and an emerging and aspirational middle class. Other shifts are also taking place. Recent news of wage increases, although not ideal for China’s export competitiveness, should be positive for domestic consumption.

Furthermore, the recent announcement that China would end its de facto dollar peg and return to the managed float system could strengthen the renminbi by better reflecting its intrinsic value. This shift in policy is a positive development for China, according to HSBC Global Asset Management.

“Overall, the possibility of a stronger currency will help attract more capital inflow into China as investors can benefit from potential asset-price appreciation. We maintain the view that renminbi appreciation will be gradual,” Timberlake said.

“Companies with large foreign currency denominated debt, such as airlines, or companies with foreign currency costs but with renminbi revenue will benefit from appreciation. Although export-related companies will be negatively affected as a stronger renminbi will reduce export competitiveness, we are positive on the dominant companies as we believe they will be able to pass on the added costs. This is because the manufacturing market in China has consolidated following the fallout from the global financial crisis. Exporters that have survived and are still in business should have gained market share and increased their bargaining power with customers.”

Brazil

Jose Cuervo, manager of the HSBC GIF Brazil Equity fund, argues that sovereign discipline and relevant market reforms over the past 20 years, along with strong global growth over the past decade, have been responsible for fuelling the accelerated economic expansion in Brazil.

Citing a stable sovereign outlook and reduced inflation expectations as examples, Cuervo argues that this has set the platform for Brazil’s continued expansion and increased domestic consumption.

“This has become a more important driver of the economy, a trend that is set to continue, especially given increasing urbanisation levels, favourable demographics, improved access to credit and strong pent up demand,” Cuervo said.

In Brazil, Cuervo currently favours a range of domestic consumption oriented stocks with greater emphasis on areas less sensitive to interest rate increases.

India

The biggest underweight country in HSBC’s BRIC portfolio is India, which remains expensive in emerging market terms at 14.2x calendar 2011 earnings. Nonetheless, this economy is in robust shape. On Monday, Moody’s upgraded its local currency debt rating, citing government's recent fiscal reforms and a strong economy.

Sanjiv Duggal, manager of the HSBC GIF India Equity fund, said he had expected upgrades such as this, and anticipated further upgrades in the next 3-4 quarters.

Despite the market being expensive, he said there are still plentiful opportunities amongst consumption related sectors such as housing, auto and beverages.

A particular pocket of opportunity is passenger car sales. For instance, in the fiscal year ended March 2010, passenger car sales in India grew at the fastest pace in six years, up 25% to 1.53 million units. Meanwhile, the housing market continues to witness strong demand and Duggal continues to find opportunities amongst the under owned real estate sector.