Image: Very old, worn and crumbling brick wall © Royce DeGrie, Photodisc, Getty Images

Whatever happened to the BRICS? Remember them?

The stock markets of Brazil, Russia, India, China and South Africa were supposed to leave the rest of the world in the dust. The BRICS were the best new idea since hand-pulled noodles.

Lagging performance is what happened.

In 2012, the U.S. Standard & Poor's 500 Index ($INX) returned 16%. Year to date, as of April 24, the return was 10.61%. The five-year average annual return was 5.05%

And for the BRICS? (For the purposes of these numbers, I'm using iShares MSCI BRIC Index (BKF), which tracks four of these countries but not South Africa.) The return in 2012 was 15.2%, and the year-to-date return in 2013 is a loss of 4.87%. For five years, the average annual return was a loss of 5.75%.

Who needs an asset class that underperforms and that is also thought to come with greater risk than developed markets like the U.S.? It's no wonder investors have turned away.

But I don't think this is the time to throw out the emerging-market baby with the BRICS bathwater. Here's why.

Even better than emerging markets

A funny thing (that's funny peculiar, not funny ha-ha) has been going on while the BRIC stocks have been underperforming the U.S. market. Other emerging markets -- a group without a catchy name but that I'll call the emerging-emerging markets -- has been outperforming both the BRICS and the U.S. markets.

Take a look at these numbers.

The iShares MSCI Turkey index ETF (TUR) was up 65.63% in 2012 and is up 6.68% year to date. The five-year average annual return has been 8.84%.

The iShares MSCI Mexico index ETF (EWW) was up 32.84% in 2012 and is up 5.76% year to date. The five-year average annual return has been 5.05%.

The iShares MSCI Indonesia index ETF (EIDO) was up 4.55% in 2012 and is up 15.14% year to date. The five-year average annual return has been -- well, the ETF hasn't been in business that long.

The iShares MSCI Philippines index ETF (EPHE) was up 47.93% in 2012 and is up 19.07% year to date. There's no five-year track record for this ETF, either.

What's going on? And what should you as an investor do about it?

What's going on is remarkably easy to explain.

image: Jim Jubak

Jim Jubak

Hitting a BRIC wall

First, economic growth rates in the BRIC countries, while high by developed-economy standards, have been trending downward.

India's gross domestic product is projected to have grown by just 5% in the fiscal year that ended on March 31. That would be the slowest growth in a decade. In Russia, GDP growth fell to an annual 0.1% in February, below even the 0.9% year-over-year growth in January and February. Brazil's growth rate slowed from 7.5% in 2010 to 0.9% in 2012, and the consensus is for 3% growth in 2013. China shows the highest GDP growth in the group, but even there, growth looks like it will slow for 2013 from the 7.8% recorded in 2012. And 2012's growth was the slowest in 13 years.

Second, the BRIC countries seem to have hit tough economic barriers that suggest growth will stay at these levels for a while and might even drop lower. In the case of China and Brazil, the barrier is something economists call the middle-income trap.

This trap sets in when a country that has used cheap labor to fuel development based on low-priced exports finds that its living standards have improved so much (and its supply of cheap, usually rural labor has dried up) that it is no longer the low-cost export platform in a range of core industries. At that point, a country can get stuck in place or after wrenching change -- as in South Korea and Japan -- break out of that trap.

China faces that transition now. Brazil's problem is similar, but has the added wrinkles of a heavily commodity-dependent economy and a grossly inefficient public sector.

Russia seems now to be confronting its overreliance on energy exports to prop up an inefficient economy. With oil prices below the levels that the government needs to balance its budget and subsidize services and consumer goods, the economy seems headed for a crisis.

India? Well, what can we say about India? The infrastructure is shoddy, the school system produces too many graduates who aren't ready for work, and endless rules keep foreign investment to a minimum. Only India's stifling bureaucracy is truly world-class.

Third, the financial ratings of these countries are headed in the wrong direction. China's credit rating was cut to A+ from AA- by Fitch Ratings in early April. In March, Moody's affirmed Russia's Baaa1 credit rating, the third-lowest investment grade rating, but no credit company has upgraded Russia in five years. Rumors say that the ratings companies are about to downgrade Brazil. Moody's gives India a Baa3 rating, the lowest investment grade, and that company is the only one of the Big Three ratings companies to give India a stable rating.

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