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It's All a Matter of Perspective
Market performance in BRIC countries depends on one's vantage point
Sony Pictures' high-grossing film of the early spring, the terrorism thriller "Vantage Point," uses
what's known as the "Rashomon narrative style" to tell a story of an assassination attempt from
five different perspectives. Rashomon, released in 1950 and still considered a masterpiece of
Japanese cinema, employs an unusual narrative structure to emphasize the near impossibility
of obtaining the truth when there are conflicting eye-witness accounts.
The two films have much in common with an ancient tale called "The Blind Men and the
Elephant." In this story, six blind men each touch an elephant to learn what it is like. As each
one touches the part of the elephant in closest proximity, he attempts to convince the others
that the elephant is a rope, a pillar, a tree branch or whatever, depending on whether he happens to touch the tale, leg, trunk, etc. The lesson is that people's view of reality depends on their perspective. Discovering the truth isn't always easy, and wider perspectives generally make for a more accurate picture.
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 indexes and other indicators. To magnify the problem, almost every
domestic index has its own set of rules. Some are constructed using market capitalization weights; others are volume-weighted. Some take into account such variables as float, tax impacts, foreign ownership limits and liquidity. Others are designed by a committee, and in that respect more resemble a camel — a maligned beast sometimes described as the creation of a committee.
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 indexes.
Large cap vs. small cap
The issue of perspective is brought to the forefront when discussing the differences between large cap and small cap stocks. By using a consistent methodology to determine capitalization sectors, we are able to provide a globally consistent definition of large cap and small cap stocks across all countries. As Chart 1 shows, Brazil and China's investable universes of
stocks look much more like the broad global market with about 90 percent large cap stocks and
approximately 10 percent small cap stocks. India and Russia, however, have very different
profiles. Large cap stocks account for only about 72 percent of India's investable universe, but account for about 97 percent — or nearly all — of Russia's investable universe.
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 indexes are weighted to large cap, the picture would 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.
Chart 1: Large Cap vs. Small Cap Defined by Russell Indexes
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 vs. domestic perspectives
Each of the BRIC countries has at least one dominant index (Appendix A). Two of the indexes, Bovespa in Brazil and Hang Seng in Hong Kong, 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 indexes 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 indexes, may find comparisons
difficult, if not impossible. Here's a breakdown of some of the problems we see with the dominant domestic indexes, as viewed from a global perspective.
The Bovespa Index, Brazil
This index is weighted by trade volume, so only includes about 50 of the most-liquid stocks traded on the Sao Paulo Stock Exchange. De facto, the most-liquid stocks will also be primarily large cap stocks. Not only does this eliminate about one third of the large cap stocks as defined on a global basis, it eliminates the relatively large number (105) of
small cap stocks that account for some 10 percent of Brazil's total market cap. Brazil's economy is arguably the fastest-growing on the planet. Today's Brazilian small-cap stocks could be tomorrow's global large cap.
Further, because the index is weighted by volume and not by market capitalization, it would be difficult, if not impossible, to run an index fund based on Bovespa. Plus, no adjustments are made for foreign ownership limits, government ownership of shares or corporate crossownership. Therefore, global investors really have no idea whether the stocks listed on the
index are investable, which distorts the entire picture.
The RTSI and the MICEX Index, Russia
The Russian Trading System Index, or RTSI, is
Russia's official exchange indicator. Similar in function to the Dow Jones Industrial Average for
the United States, RTSI is cap-weighted, using real-time prices of the 50 most-liquid stocks listed on the Russian Trading System and selected by the RTS Information Committee. The list is reviewed every three months. In RTSI's case, market cap is based on current market prices, number of shares outstanding and free float. Like Bovespa, RTSI ignores small cap, but small cap is not much of a factor within Russia. Like Bovespa, RTSI also ignores foreign ownership
limits, therefore limiting its use by global investors.
The MICEX, which many consider the more widely used index in Russia, is somewhat more problematic from a global perspective. Inclusion is decided by a committee. The index includes small, illiquid stocks. Further, the index is not adjusted for government holdings, which can be considerable.
The BSE Sensex and the S&P CNX Nifty 50, India
The Sensex and the Nifty 50 represent the Bombay Stock Exchange and the National Stock Exchange of India, respectively. They are two of India's nearly two dozen stock exchanges. The Sensex is value-weighted and consists of the 30 largest and most actively traded stocks on the Bombay Stock Exchange. However, these stocks account for just 20 percent of the market capitalization of the BSE. The Nifty 50
also consists of just 50 companies, representing some 24 sectors.
India has a thriving small cap sector. The Russell India index, as of Jan. 31, 2007, listed 253
small cap stocks that accounted for nearly 30 percent of India's market capitalization. Small cap stocks are not represented on either the Sensex or the Nifty 50. A global investor seeking to invest in small cap stocks would have difficulty understanding India's broad small cap market just relying on these two major domestic indexes.
The Shanghai A-Share Stock Price Index and the Hang Seng China Enterprises Index, Greater China
China's situation is complicated in that there are four share classes: A, B, H and N. Some or all of the share classes are traded on the various exchanges, with varying restrictions on investors, depending on whether the shareholder is a domestic or foreign
shareholder, or a qualified institutional investor. Moreover, the exchanges use different currencies and operate under dissimilar audit requirements and financial statement standards. Table 1 summarizes major differences among the four share classes in China.
Table 1: Comparison of Share Classes in China
| Share Class |
|
Ownership |
|
Currency |
|
Exchange |
| A |
|
Domestic |
|
RMC (Chinese Renminbi) |
|
SHSE&SZSE |
| These shares are primarily owned by Chinese citizens and Chinese institutions. These shares make up most of the market from the perspective of a Chinese investor. |
| B |
|
Domestic/Foreign |
|
US$ |
|
SHSE/SZSE |
| These shares can be owned by either international investors or Chinese investors. |
| H |
|
Domestic/Foreign |
|
HK$ |
|
SEHK |
| These shares are traded in Hong Kong and primarily owned by foreigners. |
| N |
|
Domestic/Foreign |
|
US$ |
|
NYSE/Nasdaq |
| These shares are traded in New York primarily by non-Chinese investors. |
Taking just the two main indexes, the Shanghai A-Share Index and the Hang Seng China Enterprises Index (an H-share index), we find either domestic ownership or foreign ownership, either cap-weighted or free-float cap-weighted, and different currencies. There is a high level of government ownership in China, which may or may not be reflected by these indexes.
For domestic investors trying to get a sense of which direction their country's market is headed, domestic indexes may do an adequate job. In particular, 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 the past five years is creating hundreds of new companies, which are being capitalized through Initial Public Offerings. As Table 2 shows, this is particularly true among BRIC countries, which have experienced phenomenal growth of IPOs.
Table 2: Number and Percentage of Global IPOs by Region
| Region |
|
2002 |
|
2007 |
| |
|
Number |
|
Percentage |
|
Number |
|
Percentage |
| U.S. |
|
93 |
|
44.04% |
|
151 |
|
30.73% |
| BRIC |
|
7 |
|
1.09% |
|
118 |
|
27.67% |
| Emerging |
|
107 |
|
15.51% |
|
189 |
|
36.20% |
| Developed |
|
186 |
|
84.49% |
|
377 |
|
63.80% |
As part of its commitment to present the most accurate and up-to-date information about
stocks, in addition to its annual reconstitution in June, Russell adds Initial Public Offerings to
Russell indexes at the end of each calendar quarter. Reconstitution is designed to ensure that the Russell indexes represent the market. Annual frequency is the best balance between market representation and turnover costs. Adding IPOs quarterly, in addition to reconstitution, leads to an enhanced market representation without significant turnover. Table 3 shows IPOs added to Russell's Brazil, Russia, India and China country indexes on March 31, 2008.
Table 3: March 2008 Additions to Russell Global Index — BRIC
| Brazil |
|
|
| Company |
|
Market Value ($US Millions) |
| Banco Panamericano SA |
|
557 |
| Bolsa de Mercadorias e Futuros — MF&F |
|
10,816 |
| MPX Energia SA |
|
4,127 |
| Russia |
|
|
| Company |
|
Market Value ($US Millions) |
| Synergy Co. |
|
649 |
| India |
|
|
| Company |
|
Market Value ($US Millions) |
| BGR Energy Systems Ltd. |
|
956 |
| Edelweiss Capital Ltd. |
|
1,597 |
| Future Capital Holdings Ltd. |
|
1,203 |
| Mundra Port and Special Economic Zone Ltd. |
|
7,357 |
| Reliance Power Ltd. |
|
24,317 |
| China |
|
|
| Company |
|
Market Value ($US Millions) |
| Anton Oilfiled Services Group |
|
476 |
| Centraland Ltd. |
|
728 |
| China National Materials Co Ltd. |
|
1,221 |
| China Railway Group Ltd. |
|
5,029 |
| Gushan Environmental Energy Ltd. |
|
888 |
| Uni-President China Holdings Ltd. |
|
1,998 |
| VanceInfo Technologies Inc. |
|
293 |
| VisionChina Media Inc. |
|
716 |
| Xinyuan Real Estate Co Ltd. |
|
885 |
Conclusion
About a year ago, on Feb. 27, 2007, an event occurred in the Chinese stock market that dramatized 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
nine percent, the most dramatic one-day decline in a decade. According to media reports, the drop "vaporized" more than $100 billion in market value from stocks traded on most exchanges. In contrast, the Russell China index dropped about 3 percent 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.
Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company.
Russell Investments is the owner of the trademarks, service marks and copyrights related to its respective
indexes.
Indexes are unmanaged and cannot be invested in directly.
This is not an offer, solicitation or recommendation to purchase any security or the services of any
organization.
This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an "as is" basis without warranty.
Copyright © Russell Investments 2008. All rights reserved.
First use: March 2008
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