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Herro: Use Caution in BRIC

Just because an economy is booming doesn't mean you should buy the stocks in that market, says International Manager of the Decade David Herro.

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John Coumarianos: Let's talk a little bit more about emerging markets. You mentioned that you're gaining some exposure to them through the luxury goods makers. But you recently wrote about the so-called BRIC countries and the emerging markets in a shareholder letter. If you could repeat, for the audience, what you wrote in that letter and why you have the exposure you do to emerging markets.

David Herro: Quite clearly, the BRIC countries today--and the BRIC, Brazil, Russia, India, China--are what is going to propel this world to grow at an above-average rate over the next 20, 30, 40 years. And in particular China, and in particular India, because that's two billion people. One-third of the world's population is in these places.

And we're getting to an inflection point, certainly in China, where it used to be, if the average GDP per head was a couple hundred dollars, if it grows at 2%, big deal. $200 times 10%, that's $20 on the margin. But when it's $4,000 or $5,000 or $6,000, and that grows at 10%, it begins to give us real economic growth. So this is what's happening. And that's a really good thing.

And the next question is, well, why are you underexposed? Why aren't you invested? Because--again, I'm going to keep repeating myself--value is price and quality. And if prices are expensive and the quality of the underlying businesses isn't good, we're not really interested.


What do I mean by quality not being good? Well, the corporate governance is often murky or unclear. In China, for instance, all the major H-share companies have who as their major shareholder? The government. And what happens is there's a conflict: "Should we run the company for the shareholders, or should we run it for government policy?" And most times that government policy works when it's the government who owns the company or controls it. So this has to be priced in.

It's not saying we would never invest. We'd say we only invest if they're selling at discounted prices. And Russia, of course, we don't even consider, because there's just no corporate transparency. There appears to be no rule of law. And Brazil, it's just a matter of price.

So we do invest in these places. And people may recall, in the late '90s, we were way over-invested. We had almost 30% in emerging markets.

So if the price is right, we'll do it. But we think you just cannot extrapolate what is happening within a macroeconomy and say, "This economy's booming. You have to buy the stocks." In fact, I point out that it's often counter. That is, if the economy's booming, it's often overly reflected in share prices, and perhaps what you should be looking for is places where the economy isn't booming to look for really good quality selling at low prices.

Coumarianos: So you're going to get growth in emerging markets. But of course, as it almost always is, that's just priced into the stocks right now.

Herro: That's right.

John Coumarianos does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.