For years the four mighty BRIC nations have grabbed increasing shares of world investment flows. But the coming years may not be so kind.  These countries bring up the bottom of the Economic Freedom Index (EFI) for 2012. Compiled by Washington D.C.-based think-tank The Heritage Foundation the EFI measures 10 freedoms —  from property rights to entrepreneurship – and according to a note out today from RBS economists, there is a strong positive link between a country’s EFI score and the amount of FDI (foreign direct investment) it can secure. So the more “free” a country, the more FDI inflows it can expect to receive — that’s what an RBS analysis of 2002-2008 investment flows shows.

So back to the BRICs. Or BRICS if you add in South Africa (part of the political grouping though not yet included in the BRIC investment concept used by fund managers). The following graphic shows Russia languishing at the bottom of the EFI, China just above Russia and India third from bottom.  Brazil is sixth from bottom while South Africa ranks two places higher.

Over the past year emerging markets have broadly lagged an upswing in global equity markets, yielding cumulative returns of 4.5 percent since last August. That’s less than half the return developed markets have provided (see graphic below).

But there are two reasons why a  turning point may be approaching. First the positioning. Foreign holdings of emerging equities have plunged in the past six months and according to research by HSBC they are at the lowest in four years. That’s especially the case in Asia, where fund managers have been jittery about China’s growth slowdown.

The European Union has given Budapest the green light to seek aid from the IMF. (see here)  In fact, the breakthrough after five months of dispute does not let Hungary completely off the hook  — to get its hands on the money, Viktor Orban’s government will have to backtack on some controversial recent legislation, starting with its efforts to curb the central bank’s independence.  It remains to be seen if Orban will actually cave in.

But markets are reacting as if the IMF money is in Hungary’s pocket already. There have been sharp rallies in Hungarian dollar bonds,  CDS and currency markets (see graphic below from Capital Economics). The Budapest stock market has posted its best one-day gain since last November while the yield on local 10-year bonds have collapsed almost 100 bps. Hungarian officials are (a bit prematurely)  talking of issuing bonds on world markets.

Ukrainian officials were at pains to reassure investors last week that no debt default was in the offing. But people familiar with the numbers will find it hard to believe them.

The government must find over $5.3 billion this year to repay maturing external debt, including $3 billion to the IMF and $2 billion to Russian state bank VTB. Bad enough but there is worse:  Ukrainian companies and banks too have hefty debt maturities this year. Total external financing needs– corporate and sovereign – amount to $58 billion, analysts at Capital Economics calculate. That’s a third of Ukraine’s GDP and makes a default of some kind very likely. The following graphic is from Capital Economics.

The desperate days when Chinese property developers offered free cars as an inducement to homebuyers look to be over.

Sales and earnings figures indicate some of the gloom is lifting as developers have enjoyed a second straight month of rising sales. Vanke, China’s biggest developer by sales, said last week that March sales had risen 24 percent year on year, while  2011 profits rose 30 percent. Another firm, China Overseas Land, posted a 21.5 percent profit rise last year.

Now that the Fed appears to have dashed any lingering hopes for an imminent QE3, what’s next for emerging markets? Most observers put this year’s stellar performance of emerging bonds, currencies and equities largely down to the various money-printing or cheap money operations in the developed world. That’s kept core government bond yields bumping along near record lows and benefited higher-yielding emerging assets.

Many would add that in any case a solid economic recovery in the United States should be fairly good news for the rest of the world too. Not so, says HSBC. It argues that a better U.S. outlook is not necessarily good news for emerging markets simply because the side effect of economic improvement is a stronger dollar and higher Treasury yields and that’s an environement in which EM assets tend to underperform.

It’s been a while since Chinese stocks earned investors fat profits. Last year the Shanghai market lost 22 percent and the compounded return on equity investments there since 1993 is minus 3 percent. This year too China has underwhelmed, rising less than 3 percent so far. Broader emerging equities on the other hand have just concluded their best first quarter since 1992, with gains of over 13 percent.

Given all that, bears remain a surprisingly rare breed in China. A Bank of America/Merrill Lynch’s monthly survey found it was fund managers’ biggest emerging markets overweight in March and that has been the case for some months now.  Clearly, hope dies last.