Latin American ETFs: Carnival spirit rising

Latin America has produced some sparkling returns in the last few years and with Brazil leading the way, prospects continue to look promising. Nick Sudbury reports

The emerging markets of Latin America are dominated by Brazil, which has the tenth largest economy in the world. Analysts are forecasting the country’s gross domestic product (GDP) growth will be six percent this year, compared to a global average of just over four percent. These sorts of figures explain why Goldman Sachs is expecting Brazil to move up to fourth place by 2050, bypassing the likes of Germany, Japan and the UK on the way.

Brazil was one of the first economies to recover from the global recession, with the two main sources of growth being the resurgent value of its natural resources and a burgeoning middle class fuelling a strong rise in domestic demand. The risk of over heating has forced policy makers to raise the benchmark interest rate to 9.5% in an effort to bring inflation back to its 4.5% target. 

Long-term gains

There are only three Latin American ETFs with a five-year track record and between them they have delivered an impressive average return of 305%. The top performer was the iShares MSCI Brazil Index single country fund, which was up 389% over the five-year period. This reflects the strength of the market recovery following a sharp sell-off in 2008.

The iShares ETF, domiciled in Ireland, has just over one billion US dollars in assets under management (AUM) and has a total expense ratio (TER) of 0.74%. The fund replicates the index by investing in the underlying shares, and currently has 78 holdings. The largest of them is the oil producer Petrobras, which has a 20% weighting in the portfolio. 

Nizam Hamid, head of sales strategy at iShares Europe, says the focus for many clients is the commodity and growth related aspects of Brazil, which tie in with the general emerging market themes that have been prevalent over the past year.

He says: “MSCI Brazil has over 51% exposure to energy and materials stocks compared to 30% for MSCI Emerging Market World. From an ETF perspective, the recent Brazil ETF flows have been equivalent to the flows into Chinese equities.”

The volatility of the iShares ETF reflects the high level of single stock concentration in the underlying market. This makes Brazil more volatile than either Latin America or MSCI Emerging Markets World, but investors have been well rewarded for the extra risk by some impressive outperformance.

Another excellent long-term performer is the iShares S&P Latin America 40 Index fund, which is up 317% in five years. This offers greater diversification in exposure by investing in stocks from Brazil, Mexico, Chile and Argentina. The fund is domiciled in the US, has a TER of 0.5% and AUM of just over $2.7bn. 

“The fund is optimised for liquidity, tracking error and holding constraints relative to the benchmark,” explains Hamid. “The main reason it has no holding in Petrobras is to offer a broader regional exposure, with Brazil making up 63% of the index, Mexico 22.4% and Chile just under 11%.” 

Volatile returns 

The returns from the region over the last three years have been extremely volatile, with iShares MSCI Latin America providing a typical example of what investors have experienced. In May 2008 this fund peaked at over £16 a share, before the global stock market sell off induced a collapse to £6.80 in October. It then took another year to recover the lost ground. 

The performance since the market lows 12 months ago has been impressive, with the 17 available funds producing an average gain of almost 63%. Leading the way was the Global X/InterBolsa FTSE Colombia 20 ETF with a return of 87%. 

Evelyn Hu, institutional relationship manager at Global X Funds, says Colombia is one of the largest economies in South America, but Latin American funds have a very low exposure to it, normally in the range of one to three percent. 

Hu says: “Colombia represents eight percent of the regional GDP and capital market size. It is classified as a frontier market, although it is much more developed than most people realise. The country has implemented a series of economic reforms that have resulted in impressive growth rates and shrinking national debt.”

The Colombian economy is fairly diversified, with financials, oil, industrials, and consumer segments all well represented. Somewhat surprisingly, the market index has been less volatile than the S&P 500 over the last three years. It also has some attractively low correlations. 

“Over the past three years, the FTSE Colombia 20 index recorded correlations of 0.30 with the S&P 500 and around 0.35 with the Latin American indices. This makes it a great diversifying agent to a US portfolio, emerging markets portfolio, or even a Latin American portfolio,” says Hu. 

MSCI Latin America 

The majority of the funds investing in the region track the MSCI Emerging Markets Latin America index. This is a free float market cap weighted benchmark currently comprising 125 stocks. Almost 70% of the exposure is in Brazil, with a further 19% in Mexico and the majority of the balance split between Chile and Colombia. The main sectors are materials, financials and energy.

The db x-trackers MSCI Latin America Index ETF is domiciled in Luxembourg and is available on various stock exchanges in Europe. Most of the different listings were launched within the last few months, with the only exception being the Swiss version, which has returned 63% over the year. 

Manooj Mistry, head of db x-trackers UK, says investors can use this ETF to get broad exposure to large and mid-cap companies in Argentina, Brazil, Chile, Colombia, Mexico and Peru. “By combining it with the global MSCI Emerging Markets ETF and the other subsets, investors can go underweight or overweight to Latin America within their portfolio.” 

The issuer also offers ETFs tracking the MSCI Brazil or MSCI Mexico indices, which investors can combine with an ETF on the MSCI EM Latin America index to go overweight these economies. 

The strong returns from the region have prompted providers to launch around 20 new ETFs in the last few months. These include a range of iShares funds linked to different parts of the Brazilian Bovespa index, denominated in the local currency. 

“These are Brazil domiciled funds with a general focus on local investors and their increasing use of ETFs,” explains Hamid at iShares. “The other iShares Brazil related ETFs are listed overseas and offer low cost, easy access to a Brazilian exposure based on the MSCI indices, which are typically the main benchmarks that foreign investors use.”