How to Survive Getting Hit by a BRIC

Now I know what it feels like to get hit by a BRIC: Brazil (EWZ) -8.81%, Russia (TRF) -8.2%, India (IFN) -7.5% and China (FXI) -10.7%.  It may take a few days or weeks before our bells stop ringing, but it will.  Unless Goldman Sachs grossly miscalculated the economic potential of these countries, February 27, 2007 will simply be a blip in a long term profitable cycle.  However, hard hats will be standard issue going forward.

I believe this action lends credence to my quest of developing indirect methods for investing in the BRIC economic cycle.

Pseudo-ETFs

Low cost brokers and basket trading have made it financially feasible and practical to create your own “pseudo-ETFs.”  A “pseudo-ETF” is a basket of stocks fitting your criteria that can be bought or sold with one order.  Refer to my article on basket trading for more details.  Last year, I created two “pseudo-ETFs” to capitalize on the BRIC trend.  One was comprised of an equal weighted basket of EWZ, TRF, IFN and FXI (the direct method).  The other consisted of companies that provide raw materials and supplies necessary for the industrialization of the BRIC economies (the indirect method).  Both had phenomenal returns: direct +49.1% and indirect +41.2%. Their year to date performance, including the 2/27 meltdown, is direct -14.5% and indirect +3.5.  I realize that 14 months is a small data set, but it appears that the indirect method captures most of the upside while minimizing the downside.  Obviously, there is no guarantee this trend will continue. None the less, I am currently in the process of replacing the direct “pseudo-ETF” with another indirect one.

Growth Creates Opportunities

Along with economic growth are some unintended consequences such as China’s substandard drinking water and badly polluted air.  China has committed $125 billion over the next five years to address these problems.  Four companies that will benefit from this spend form the first pillar of this basket.  This was addressed in detail in my earlier article.

Another area that is experiencing great pains is the transport and logistics industry. To bring China’s manufactured goods to Europe or the US, to ship Brazil’s cars or to supply China’s demand for raw materials more ships, trucks and airplanes are needed each year.  This boom has created congested ports, railways and roads. 

The infrastructure in China and the other BRIC countries are years behind developed countries.  The following story from Logistics Management paints the picture.

Just before Christmas, somewhere in Tianjin or Chongqing or almost any other major city in China for that matter, a truck was being loaded with parts destined for a factory elsewhere in the country. The factory managers worried about when the goods would arrive. They knew how much red tape they would have to wade through to get the parts they needed.  If anything is likely to crimp China’s growth, it will be logistics bottlenecks. Freight transportation can be downright primitive by global standards; there’s a fair chance that the truck in Tianjin was loaded by hand, that its driver had to pay off a low-level government official somewhere along the road, and that the condition of the road itself made for unpredictable delivery.

According to China Logistics 2006, the latest report from U.K.-based research firm Transport Intelligence (TI), it has long been understood that if China’s economy is to maintain its momentum, its logistics costs—currently up to three times the level of those in developed countries—must come down.  Jones Lang LaSalle, a global services consultancy, expects China’s logistics market to double from $105 billion to $210 billion by 2009.

The Opportunists

The goal is to identify global companies that will benefit from this spend.  However, since the ultimate objective is to create a “pseudo-ETF” the companies must trade on a U.S. stock exchange. 

Air Freight:

UPS (UPS) – has been in China since the 1980s.  UPS Supply Chain Solutions entered the market in 1998 and now is one of the area’s leading 3rd Party Logistics companies.  Its services include transportation, warehousing, international air and ocean freight and customs brokerage.

Fed Ex (FX) – the world’s largest express transportation company.  Entered China in 1984 and employs more than 2,300 people in China.

DHL – would be an excellent choice, but it does not trade in the U.S.

Express Package:

TNT N.V. (TNT) – Dutch postal and express mail company with operations in high-growth markets of Brazil and India, among others.

Logistics Outsourcing:

Many of the large 3rd Party Logistics companies are private, thus are not eligible to be added to the “pseudo-ETF.”

C. H. Robinson Worldwide (CHRW) – one of the world’s largest third-party logistics companies, CHRW offers shippers a wide range of customized global transportation, logistics and supply chain management solutions. CHRW doesn’t own equipment.  Its relationships with truck, rail, ocean, and air carriers mean more equipment options and greater flexibility to bring freight to market.  CHRW has been serving customers in South America since 1991 and has 8 offices in China and one in Hong Kong to
provide ocean and air freight forwarding services.

Expeditors International of Washington (EXPD) – provides logistics services worldwide. The company’s services include consolidation or forwarding of air and ocean freight. It also provides customer brokerage, distribution management, vendor consolidation, cargo insurance, purchase order management, and customized logistics information.

Rail:

Major investments are underway and more planned in China railways.  China sees railroad development as clearly an opportunity to showcase their technological innovation.  Although some foreign companies such as France’s Alstom, German conglomerate Siemens AG, Canada’s Bombardier Inc. and Japan’s Kawasaki Heavy Industries have had some success selling railway equipment and expertise to China – their preference is clearly on homegrown technology.

None

Road:

China’s highway networks have only been partly built and the road quality is quite varied.  There are more than 2 million trucking companies with between 5 and 6 million trucks in China, most operate locally or regionally.  If you have to transport something a long way often you must switch logistics providers increasing paperwork and costs.  Trucks are prone to break down and clog roads.

YRC Worldwide (YRC) – is one of the largest road carriers worldwide. It has announced its intentions to enter the trucking arena in China in 2007.  Its logistics arm has partnered with one of China’s largest freight forwarders.

The Data Says

The results are quite similar to Indirect Method I.  Much of the gain is captured while downside is minimized.  I could be accused of curve fitting, but I believe the overall approach is valid.

BRIC Indirect II:  VE, SZE, SBS, CVA, UPS, FDX, TNT, CHRW, EXPD, YRCW

      Indirect II  Direct Method
2006 Return    +33.7%     +49.1%
YTD Return (as of 2/27)    + 4.0%     -14.5% 

Conclusions

The BRIC transport and logistics industry is very fragmented and local.  Many of the major players are either private companies or are not listed on U.S. stock exchanges.  This significantly reduces the available companies to choose from.  I am not quite satisfied with this current mix of stocks and will continue tweaking it over the next few weeks.  Hopefully by then, the ringing in my head will have stopped.

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  • I hope the bell stop ringing, because my portfolio is hurting, I login this morning and said What the Fluke !

    FXI—is hurting big time !

  • As you know, I play the BRIC trend in a couple different ways – direct and indirect methods. Since it has been underperforming, I have been selling off the direct method which includes FXI all year. Yesterday, I punched out the direct method completely. Obviously one day late or maybe one day early since it is bouncing back today. I hate when that happens. I am going to give the direct method a break for awhile and only use the indirect method to play BRIC.

  • Great article the author has another good article the subject and opens up an important debate. I agree with the author on Claymore BRIC ETF EEBs disproportionate allocation among BRIC countries. But I don’t agree with the premise that one will get the upside potential BRICs via individual companies with business in those countries. The infrastructure, environment issues in these countries will be partly solved by companies and mostly have to be solved by massive investments by the governments. Some of the big investments required to improve infrastructure may have very poor profit potential for companies to participate in.
    I would also argue that the individual stocks have higher risk than the broader market. I just happened to write a blog on BRIC exposure in various ETFs here

  • Randv, Thanks for the kudos and you raise some valid points. However after this week, I really believe that the indirect approach is the best strategy. As you know Claymore ETF is really new, so most are probably playing this trend using the country ETFs – EWZ, FXI, etc. Personally I wouldn’t want to touch China’s stock market for at least 6 months. There is a tremendous amount of speculation in that market and the government wants it to cool off.

    However, its economy will continue. Roads, bridges, railways will continue being built. Thus the need for raw materials, construction equipment and know-how will continue. The BRIC countries are each independent. Maybe if they formed some kind of cartel they could have some pricing power, but it is a free market. China will pay market prices for iron ore, copper, etc. and the companies supplying such will continue profiting.

    If the BRICs could solve their problems themselves, I agree that the profit potential for state-run companies would not be much. In many cases, they simply need outside expertise.

    I may not have found the best mix of stocks yet, but really like this approach.