Thomas Gerhardt

Head of Global Emerging Markets at DWS Investments (Deutsche Bank Group)

The market cap of BRIC countries will increase significantly into the level of the GDP

Publié le 02 Novembre 2007

Do you think the term “BRIC” is relevant?
BRIC is a name that doesn’t legally exist. It is not like European Union or like NAFTA. It is just a forecast to call Bresil, Russia, India and China. The name was created by Goldman Sachs in a study.
It’s nothing else than a combination of four countries. Is this combination relevant?  I think yes, it is for our product. 

Some experts say that the name BRIC is a just a business concept. Others tell you it is possible to add other countries into the term, like Taiwan or Korea. What do you think about it?
Because it is a business concept, you could create several of different group. So you could add Korea and have the term BRIC with a K in the end.
But the more relevant term is BRIC first because Goldman Sachs has written this study, and then because we and some other great players like HSBC have created BRIC as a specific investment area into a concentrated emerging market fund.   

How could you explain the BRIC is such a lucrative area for investors?
Out of all the emerging markets, the four great countries have a combination of two very positive factors : very good prospects and critical size.
These countries will play an important role in the global economy in a decade or a little bit longer.
It is the reason why it is such a lucrative area for investors.

The BRIC products are highly competitive when compared to their equivalent in developed countries or to the “global emerging” index. Why?
Actually, if you compare BRIC to developed countries it is a different asset class. Either you invest in developed countries, in US, Europe, Japan, or you invest in BRIC or you invest in both.
I wouldn’t say it is a comparative situation. It is an investment in addition to investment in developed countries.
Then, are they competitive to the global emerging market index? Yes, they are. But in another side, they are a big composite the GEM index. They are the four most important markets in the GEM.

Could you give us examples of domestic reforms that would allow a convergence with the operation of economic activities in developed countries?
The biggest change which happened has been the change in China. The Chinese government opened the country to become step by step from a communist country, a big part of the global economy today.
Thus, China has joined the WTO, and has allowed foreigners companies to invest in Chinese companies.
It is a limited investment of course, but it doesn’t do it one shot. It is a long process.

Except China, are there similar situations in the other countries?
If we consider Russia, the Russian government has realised that it hasn’t lot of naturally reform into the ground. They haven't been able to do all the necessary investment. So the government allowed foreigners to become part of joint venture companies in the country, for instance Shell, BP, Total…
The country took legally reforms which are big step opening the economy to the rest of the World.

In Brazil, when the President Lula was elected 5 years ago, the financial community was very afraid of the political scenario. Lula made some legally reforms in order to open the economy. He made sure the inflation came down dramatically because Brazil has enormously provided inflation for decades. As a result interest rate came down radically.
Lula changed the way for investors. Brazil represented higher risks, huge corporate deficit. Lula succeeded to improve the situation.

For India, it is very simple. 5 years ago, India was essentially an agricultural based economy with a very little economy connected to the rest of the world.
The biggest catalyst for India was also the success of China. This opened a lot of eyes in the country. Why has China been so successful and why not India?
Many things were done to follow China.

What are the main risks of investing in these countries? Are there specific risks for each country?  What do these risks consist in?
Investing in emerging market always suppose some risks. But what about specific risks?
About Russia, you do have the risk that the president Putin is not allowed to get re-elected next year. He made it very clear that he wouldn’t change the constitution. So we are going to have a new president next year. First we don’t know who it would be. And moreover, we don’t know what the political guidelines of this one will be.
So, there is an important political risk. We all know Russia is a big country and a lot of people do have a lot of interest.

Another risk in Russia concerns corporate governance.

As for China, the biggest risk is that it is not so easy to manage such a huge economy. China will go its way but not in a linear function. Economy and stock market will always over hit, under shoot, over hit…
Then, China lacks investors. Risks in the Chinese stock market will always shoot on the way up. Then probably turn around to the same thing in the way down.

People always think that 8% gross every year. It would be another thing: 9,10, 11% …
People would be nervous if the gross flows down.
Another risk concerns capital management. Hopefully, the companies will focus on profitability gross. Too companies really will just focus on profitability gross and just invest for gross because stock markets are driven by earning gross, not by top line gross.

India, like China, both have inflation risks mainly because of agricultural prices which are going up. In India, central bank probably has to raise interest rate further, which could then possibly slow down gross.

About Brazil, I think the biggest risk is a significant slow down of the world economy. This could have an impact in the demand of commodities.
I don’t see political or social risk.

How do you manage these risks? What systems do you have to control them?      
The answer is not simple. There is no system were you can enter any risk and you can really measure it. You have to follow some sectors more. It is not like a machine which allows you to have a clear perception of the proportion of the risk in order to make you change your portfolio.
It doesn’t work that way.

If the world economy really slows down, you really have to adjust your portfolio structure. You need to have more defensive, more locally dominated sectors like local consumption, utilities, telecom… and less exported sectors.

If we consider the political risk in Russia, it goes up the Russia’s shares. You will also put money into cash or other markets.
The question is, how can you measure that political risk?  It is difficult. You just have a feeling about who will be the next candidate or if there will be a change in the political action.

Are there some guarantees?
There are no guarantees. That doesn’t mean that we don’t control risks. Models exist by sectors.

Did you encounter any legal issues when investing in these countries?
We never had any legal issues. We avoid investments which could suppose legal problems.

Do you think it would be preferable if more freedom was granted to the international investors in these markets?  How could this be possible?           
Of course, we would like more opening in these capital markets. Actually, in China, I can’t invest in every single sector. We have a limited number of shares we can invest in.
Additionally, corporate governance is a risk in a few markets. It should improve, mainly in China and Russia.
Except in India, where the corporate governance is at a very high level.

Do you think that the authorities will allow more freedom? Why?
All these countries become successful because they have a huge need for foreigners investments. A lot of projects have been possible thanks to foreign investment. So if they want to go on to be an important part of the world economy, they must take reforms to open their capital market. But they will do it step by step. China will not allow tomorrow full free for investment.
We all know that the Russian government owns an agenda where it decides to keep control over some specific sectors.  
I think the situation will evolve.

How do you think the financial market will evolve in these countries? Do you think there will be more financial players? What kind of financial actors in particular?
The way financial market will locally function will be quite similar to the way the financial market functions in the rest of the world.
China is the best example. I mean in China, Equity market doesn’t exist, there are two separate markets: A share market for local investors where there are huge public guarantees because China investors have lot of money and can’t invest out of the rest of China; and all the other share class for foreign investment.
This is going to change. We are going to have local investors for China, local retail investors and more institutional investors like pension fund, like assurance companies, like retail funds companies. 
Foreigner professional investors will also much play a bigger role in future.

In how much time do you think it will be possible?
I think it will be possible in five or ten years.

Some experts say that India is the most expensive emerging market. What do you think about it?
I agree. But I’m not worried about it because there is a reason why India is the most expensive emerging market.
The Indian market has more than 20% of the market cap in software. These companies are earning gross between 40 and 50%. So they are more marketable.
Then, Indian market is more competitive first because corporate governance of the listed companies and because the management.

There is currently a big discrepancy between economic stance and equity market capitalisation. Do you think this will change? 
Economically emerging markets, in particular BRIC are already playing a significant role. They represent much more than the third world gross. We think that the market cap will increase significantly into the level of the GDP.
Not only the stock segment but also all the component of the markets.

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