Market performance in BRIC countries depends on one's vantage point, argues Russell Investments' Kelly Haughton
Rashomon, released in 1950 and still considered a masterpiece of Japanese cinema, employs an unusual narrative structure to emphasise the near impossibility of obtaining the truth when there are conflicting eye-witness accounts.
So it is with attempting to describe and measure domestic stock markets around the world. Whether in developed countries, or in emerging markets such as the BRIC countries - Brazil, Russia, India and China - investors searching for the truth about an individual country's market must study any number of indices and other indicators. To magnify the problem, almost every domestic index has its own set of rules. Some are constructed using market capitalisation weights; others are volume-weighted. Some take into account such variables as float, tax impacts, foreign ownership limits and liquidity.
As a result of these multiple and multiform measures of the market, domestic and global investors will rarely be in accord on their perspective of individual markets. For the global investor, the problem is compounded as he attempts to get perspective about markets across several different countries - all with their own form of index or indices.
Large cap versus small cap
The importance of perspective is brought to the forefront when discussing the differences between large cap and small cap stocks. Using Russell Indexes, which employ a global-relative definition of large cap and small cap, provides one perspective.
Brazil and China's investable universes of stocks look much more like the broad global market with about 90% large cap stocks and approximately 10% small cap stocks. India and Russia, however, have very different profiles. Large cap stocks account for only about 72% of India's investable universe, but account for about 97% - or nearly all - of Russia's investable universe. For another perspective, a domestic investor in either India or Russia might follow the S&P CNX Nifty 50 or the MICEX Index, respectively.
However, because both of these indices are weighted to large cap, the picture could be an incomplete one. For instance, someone considering whether to invest in India needs to understand the strength of that market's small cap sector. Of the top-performing 100 global securities in 2007, based on total return, 41 were in India, and 32 were small cap. In developing a global perspective on stocks around the world, therefore, it is important to have a globally consistent set of rules on measuring stocks available for investment and how they are classified.
A stock defined as large cap in India should be considered large cap if it moves its corporate headquarters to Russia. From a global perspective, a company should be either a growth stock or a value stock regardless of whether it is in Brazil, Russia, India or China.
Global versus domestic perspectives
Each of the BRIC countries has at least one dominant index. Two of the indices, Bovespa in Brazil and Hang Seng in Hong Kong, were formed in the 1960s; others such as the RTSI (Russian Trading System Index) and the MICEX in Russia, and the SSE Composite in China, were launched in the 1990s.
The indices are well-used and well-respected in their home countries and around the world.
However, global investors who want a consistent way to gauge capital markets in BRIC countries, or in any country, if they rely only on domestic indices, may find comparisons difficult, if not impossible.
For domestic investors trying to get a sense of which direction their country's market is headed, domestic indices may do an adequate job. For instance, since A-Shares are the primary way for Chinese investors to participate in the stock market and are difficult for foreign investors to buy, the Shanghai Share index is more representative of local investor returns than a properly constructed global index.
But for global investors who want to compare one country's capital market with another, or with a group of countries, a globally consistent approach is required.
Initial public offerings
Another area where perspective can play an important role is in new issues. The rapid growth of developing countries in the past five years is creating hundreds of new companies, which are being capitalised through initial public offerings (IPOs). As Chart 1 shows, this is particularly true among BRIC countries, which experienced significant growth of IPOs between 2002 and 2007.
On 27 February 2007, an event occurred in the Chinese stock market that dramatised the difference between global and domestic perspectives. The Chinese stock market was shaken to its core when the Shanghai A-Shares Index and others fell more than 9%, the most dramatic one-day decline in a decade.
According to media reports, the drop "vaporised" more than US$100bn in market value from stocks traded on most exchanges. In contrast, the Russell China index dropped about 3% that day since it does not include A-shares. To completely understand the capital markets, one needs look at them from a variety of perspectives. This is especially true of markets with significant foreign ownership limits and government holdings.
China is a prime example of this and one where we see continuing changes to the rules. This means continuing monitoring of the situation to be able to measure the markets according to the real-life possible trading strategies available to various investors.
The Bovespa Index (êndice Bovespa) is a total return index weighted by traded volume. It's made up of about 50 of the most liquid stocks traded on the S‹o Paulo Stock Exchange. The portfolio is rebalanced every four months, January to April, May to August, and September to December. The Bovespa Index has been divided ten times by a factor of ten since 1 January 1985.
The Russian Trading System Index, or RTSI, is a capitalisation-weighted index of the 50 most liquid Russian stocks listed on the RTS and selected by the RTS Information Committee. The constituent list is reviewed every three months. Market capitalisation is based on current stock prices, number of shares outstanding and free-float factor. The MICEX Index (previously called the MICEX Composite Index) is a market capitalisation-based index of the most liquid stocks of Russian issuers listed on MICEX (the Moscow Interbank Currency Exchange). An Index Committee determines the principles of including securities into the index calculation.
India's Bombay Stock Exchange Sensitive Index, also known as the BSE Sensex or BSE 30, is a value-weighted index consisting of the 30 largest and most actively traded stocks on the Bombay Stock Exchange. Established in 1875, the BSE is considered the oldest and largest stock exchange in South Asia. The 30 companies account for about 20% of the market capitalisation of the BSE. The S&P CNX Nifty 50, a weighted-average index, is an index of large companies on the National Stock Exchange of India. It consists of 50 companies representing 24 sectors of the economy.
The Shanghai A-Share Stock Price Index is a capitalisation-weighted index that tracks the daily price performance of all A-shares listed on the Shanghai Stock Exchange, which are restricted to local investors and qualified foreign institutional investors. The Hang Seng China Enterprises Index is a free-float capitalisation-weighted index comprised of H-Shares listed on the Hong Kong Stock Exchange and included in the Hang Seng Mainland Composite Index.
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