BKF - BKF: A Chinese Indian And Brazilian Equity Fund With Strong Potential

2023-05-22 17:17:02 ET

Summary

• BKF invests in the so-called "BRIC" equity markets, but excluding Russia.
• The fund is mostly exposed to China, however, India and Brazil together represent about 38% of the fund.
• BKF appears to be undervalued, notwithstanding political risks and the high associated country risk premia.
• In a relatively stable political environment, or simply without a war concerning China/Taiwan, I think BKF should perform well over the long run.

Introduction

iShares MSCI BIC ETF ( BKF ) is an exchange-traded fund that invests in Brazilian, Indian, and Chinese stocks; three major emerging markets. The expense ratio is on the higher side at 0.69%, while net assets under management were sub-$100 million at $76.4 million as of May 19, 2023, following a year of negative net fund flows (-$21.84 million).

The fund is relatively well diversified, with 628 holdings as of May 19, 2023. The top 10 holdings represented 28.73% of the fund as of recent, as depicted below. This reflects a relatively modest degree of concentration.

In terms of geographical exposures, BKF's composition favors China at 61.89% of the portfolio as of May 18, 2023. India represented 27.26%, while Brazil represented 10.58%. Cash and/or derivatives make up the small remainder.

Risk and Volatility

BKF's geographic exposures mean that the fund should be viewed in line with weighted local risk-free rates and country risk premia. Using 10-year yields and data from Professor Damodaran , I estimate the local weighted risk-free rate as 4.87% with a country risk premium of 2.34%. This is worth accounting for in any valuation.

Further, the fund is a little more volatile than the S&P 500 U.S. equity index, at 1.14 on a three-year, monthly basis. BKF does however have the potential to outperform, subject to value; upside-only beta is approximately 1.23x. More interestingly, BKF's three-year correlation with the S&P 500 is low, at circa 0.36x, which means that you have the potential for some uncorrelated alpha if BKF purchases are timed well. No doubt, you have risk associated with China's political governance especially, with BKF being a quasi-China fund given the high level of concentration. Nevertheless, in stable markets, Chinese equities have the capacity to perform well all the same.

Return Profile

BKF's benchmark is the MSCI BIC Index . The most recent factsheet for the benchmark index, which serves as a proxy for BKF's portfolio, reported trailing and forward price/earnings ratios of 13.21x and 11.19x, respectively, with a price/book ratio of 1.66x. The indicative dividend yield was 3.14%. Altogether, the data suggest the forward return on equity as being 14.83%, which is not super-high but reasonable. Further, forward one-year earnings growth is expected to be 18.05% based on these ratios.

Separately, I have retrieved a three- to five-year average earnings growth estimate from Morningstar for BKF which places earnings growth at 13.37%. However, the implication there is a rising return on equity. Therefore, to be more conservative, I have chosen to take a midpoint of about 11.3%, which reflects a more stable return on equity. All considered, and holding most factors constant including the forward earnings multiple, I arrive at an IRR of 15.92% over five years.

The forward earnings multiple of 11.19x might seem low, but I think it is acceptable given the idiosyncratic risks associated with BKF's investment geographies. One risk, for example, is the potential for a war concerning China and Taiwan. However, one could take an optimistic view; Russia has struggled greatly with its invasion of Ukraine which escalated in Q1 2022. Russia has been sanctioned heavily globally as a result. It is very possible that war over Taiwan will not materialize, and that funds like BIC will out-perform owing to the high embedded risk premiums associated with Chinese stocks.

In any event, in a "stable state", BKF appears to offer an attractive return profile. Even accounting for historical fund volatility, BKF's return potential (using my slightly sub-consensus earnings growth trajectory) is firmly above average in my view and in light of other ETFs I have reviewed recently.

I also like the fact that BKF has some potential for "upside beta", coupled with historically lower correlations with U.S. equities. All considered, while I acknowledge the risks associated with investing in emerging markets, I am inclined to take a bullish stance. This is being slightly politically optimistic, but by taking a restricted exposure to emerging markets such as China, one can justify portfolio inclusion.

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