“Emerging markets” used to be the term given to those up-and-coming frontier nations with economic growth that translated into explosive returns for investors. Then came BRIC, an acronym coined by Goldman Sachs in 2001 for Brazil, Russia, India and China – four countries that, in 2009, accounted for a full 40% of the world’s population and an estimated 25% of its GDP.

These four countries have since been understood as a sort of second-tier investment prerogative, after the developed markets of the west. But they’re not an investing slam-dunk by any stretch. Investors still have to know where and how to allocate their emerging market assets – and they have to be fully aware of the risks. 

What Exactly is BRIC?

  • Brazil has the largest economy in Latin America and is a major energy exporter; in fact, the country’s market rises and falls to a great degree with the fortunes of the oil market. Recent finds in the Atlantic Campos Basin, some 50 miles offshore, have added heft to Brazil’s already voluminous crude exports.
  • Russia, too, is long on oil and other commodities, though the rest of its businesses have struggled in the transition from a planned economy to a free market system. Nonetheless, the country has done an enviable job of servicing its foreign debt and building central bank reserves. During the 2000s (the ascension of Vladimir Putin) Russia’s GDP had more than doubled, climbing from 22nd largest in the world to eighth.
  • India has become a global leader in manufacturing and more recently in the service based industries. It’s a wonder how many tech and customer support operations have been outsourced to that country of late. A highly educated, English speaking labor force working at low-wages has contributed to building a vast, new Indian middle class that, for the most part, buys locally.
  • China is the biggest BRIC member by both population and GDP. And with foreign reserves approaching $2 trillion in 2009, the country is well positioned to fund all of its business capital costs for years to come. For the better part of the 21st Century, China has also been the destination of choice for western multinationals keen to build or partner with that government in developing an Asian manufacturing base.

Why is BRIC Important?
Primarily due to demographics, BRIC nations should continue to dominate the emerging market landscape for years to come. Much of these countries’ continued successes, however, will be tied to the prospects of the more established markets of Europe, North America and Japan, where a significant portion of the demand for BRIC products and services resides. Developing strong local demand for those same goods and services will be a crucial part of backstopping any decrease in exports.

That said, growth rates for the BRIC nations could fall from the traditional 5% to 12% they’ve experienced recently, and still remain well above those of the west – maintaining BRIC’s white hot investment status among fund managers and individual investors alike. India’s economy, as an example, was expected to grow by 6% in 2010 while Britain’s was expected to decline by nearly 4% in 2009 and show virtually no growth in 2009/10. On its current growth trajectory, China’s economy is estimated to overtake both Germany and Britain by 2015.

Falling BRICs – What are the risks?
There are a number of risks inherent in BRIC investments as a group (not to mention those that pertain to each country individually). Collectively, BRIC nations’ markets are underdeveloped. That means problems with transparency and reporting in general. A less than mature regulatory system (and managing bodies) can also make compliance a challenge. Moreover, government intervention and, in some cases, outright cronyism, can disrupt the smooth and open function of markets, making investing there a less-than-savory experience for those who’ve come to rely on a reasonably trustworthy system of checks on the power of elected officials. A general lack of liquidity and the potential for a commodity price shocks also create increased market volatility.

Best Practices – How to Proceed
It may be that BRIC nations will outperform their first world counterparts over the next decade, but it’s not clear that all BRIC investments will do so well. It’s therefore important to allocate wisely. If one’s overall emerging market allocation runs between the traditional 5% and 8%, it would make sense to devote no more than half of that to BRIC investments. BRIC exposure should always be considered within the framework of a broader global equity allocation strategy.

Remember also that BRIC economic growth may only show up in the stock market after many years. If you decide to take it on, consider BRIC money a long-term investment. And think, too, about investing in one or two key businesses as an alternative to a broad BRIC ETF of mutual fund.

How do Investors Get Involved?
There are a variety of ways investors can play continued BRIC growth, including ETFs, mutual funds, and closed-end investment funds which can track the BRIC nations as a group or individually. To invest in specific firms that operate in BRIC countries, ADRs are your best bet. New issues are always being tendered, though, so it’s wise to investigate thoroughly before committing to any particular investment product.

BRIC investing is fraught with dangers to investors enticed by the lure of potential outsized returns. Educating oneself to the proper place of BRIC investments in a portfolio and knowing one’s own risk tolerance are crucial steps toward a positive BRIC investing experience.