Building a better BRICs trap
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Building a better BRICs trap

In a 2003 research paper, Goldman Sachs argued that the combination of Brazil, Russia, India and China (BRIC) countries has the economic potential to be larger than the G6 in US dollar terms by 2050. The countries are forecast to they will encompass more than 40% of the world’s population and have a combined GDP of almost $15 trillion dollars. Goldman predicts that China and India will be the dominant global suppliers of manufactured goods and services and that Brazil and Russia will be the dominant suppliers of raw materials. Brazil and Russia would be logical suppliers of raw materials for China and India; cooperation between the four countries would create a powerful economic bloc.

Although the relationships are logical, it is not a given that the potential will be realized. Take a look at these headlines.

  • 3/06 Radio Free Europe – Russia/China: ‘Partners’ struggle with lopsided relationship
  • 4/05 Economist – Brazil and China: falling out of love
  • 05/10 Wall Street Journal – Brazil regrets affair with China

However, these opportunities are too great not to find common ground.

  • 7/06 Chinese Gov.cn – Year of Russia in China helps deepen strategic partnership of cooperation
  • 06/9 Embassy of the People’s Republic of China to the US – Top Chinese legislator praises economic relations between China and Brazil. China and Brazil will meet their goal of bringing bilateral trade to 20 billion dollars in 2007.
  • 06/11 China Daily- Trade between China and India will reach US$20 billion this year. Bilateral trade between China and India is expected to reach US$20 billion this year, meeting the target set by both governments two years ahead of schedule.

Each country is well aware of the potential benefits, so these relationships will be managed with care.

Investors who have recognized this opportunity have benefited. An equally weighted basket of ETFs representing each country: Brazil (EWZ), Russia (TRF), India (IFN) and China (FXI) returned more than 45% last year. Significantly outperforming the MSCI Emerging Markets ETF (EEM, +24%), which includes all emerging market countries. This has Wall Street feverishly creating new products to capture this trend. Claymore introduced the first BRIC ETF last fall (EEB) that tracks liquid ADRs and GDRs listed on the US stock exchange. However, Claymore’s allocation of 49% in Brazil, 31% in China, 14 % in India and 6% is the ideal allocation? Last year, the Claymore allocation lost much of Russia’s gains as the Russian ETF (TRF) returned 62%.

Individual investors no longer have to wait for Wall Street products. Low-cost brokers and basket trading have made it financially feasible and practical to create your own “pseudo-ETF.” Read my article on low cost basket trading for more details.

Currently, I am using two pseudo-ETFs to invest in the BRIC theme. The first is made up of stocks that provide raw materials and supplies necessary for the industrialization of the BRIC economies. The second is simply an equally weighted basket of EWZ, TRF, IFN, and FXI. I prefer this approach over the Claymore, since I can control the assignments. So if you just want broad exposure, use Wall Street products or a variation similar to mine.

With that being said, I am in the process of rebuilding the second method. I think that in the long run there will be more advantage in addressing the specific problems facing the BRIC countries rather than the blanket approach. Therefore, the second ETF will be made up of stocks that address two main issues facing the BRICs: pollution management and logistics/transportation. I will address logistics and transportation in a later article.

Pollution management:

China’s rapid economic growth has had some very costly unintended consequences. Pan Yue, vice minister of China’s State Environmental Protection Administration, summed up the problem, in a November 2006 comment republished in the Wall Street Journal, that “China is perilously close to crisis point” with its environment. A third of China’s population drinks poor-quality water and a third breathes heavily polluted air, according to Pan. “It is true that China has made the kind of economic advances in three decades that required 100 years in Western countries. But China has also suffered a century’s worth of environmental damage in 30 years.”

China can no longer neglect this problem as it is costing the country approximately 10% of GDP every year. That equates to more than $200 billion a year. In addition, the impact of pollution on human health has become more evident and is causing social unrest among the affected citizens. In a report published in June 2006, Zhu Guangyao, deputy head of the State Environmental Protection Agency, stated that “The Chinese government will mobilize all available forces to solve pollution problems that are causing serious harm to people’s health.” In other words, serious dollars will be poured into this problem to the tune of $125 billion. Authorities plan to spend about $125 billion over the next five years to improve water supply and wastewater treatment, according to recent reports in the official media. More than $43 billion has been allocated for wastewater treatment plants in urban areas.

China’s problem is much bigger than the other BRIC countries, but they face similar problems. I believe the following companies will be the main benefactors of this cleanup effort.

Veolia Environment (VE) is a world leader in environmental services that operates in four complementary segments: water management, waste management, energy management and passenger transport. In January, he won his 21st contract in China. It operates in 19 of China’s 34 provinces and serves the water needs of 20.59 million people. The company is also very active in Russia. Since 1991, Veolia Water has held a majority stake in “Saint Petersburg – Pure Water”, a company specializing in the investigation of leaks in municipal water supply networks. In 2002, Veolia Water became the leading international water utility company operating in Russia from Moscow and currently from Saint Petersburg.

SUEZ (ES) provides equipment and services that protect the environment around the world. Its activities include the production and distribution of drinking water, the collection and treatment of wastewater, and the treatment and recovery of waste. The company operates 20 joint ventures in China. These joint ventures treat or manage water distributed to 13.5 million people in major cities, including Shanghai.

Basic Sanitation Society of the State of Sao Paulo (SBS) It is the largest water company in the Americas and #3 worldwide. The company provides water and sewerage services in the territory of the state of Sao Paulo, Brazil to residential, commercial, industrial and government customers. It distributes water to approximately 22.6 million people and also provides sewerage services to approximately 18.3 million people.

Covanta Holding Corporation (CVA) it is the fourth and last company in the environmental segment of the basket. The company, through its subsidiary, Covanta Energy Corporation, is involved in the development, construction, ownership and operation of infrastructure for waste-to-energy and independent power production in the United States and internationally. Covanta has a long history in China and recently announced a joint venture partnership with Chongqing Iron & Steel to participate in China’s fast-growing waste-to-energy market.

These four stocks will form the single pillar of the revamped BRIC “pseudo-ETF”. The other pillar will be understood by stocks in the logistics and transport sectors. Why those sectors? By some estimates, logistics accounts for 40 percent of cost of goods sold and four-fifths of production cycle time in China. This compares to around 10 percent of the cost of goods sold in the US Old-fashioned logistics approaches combined with fractured highways/railways and primitive modes of transpiration are tremendous opportunities to improve efficiencies.

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