Latin American ETFs: Good Choices

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The global downturn has dealt a blow to Latin American economies and the ETFs which track them. Latin American economies are heavily dependent on the export of raw materials. Global expansion over most of the past decade created massive demand for these exports leading to an explosion of growth in this region. But as the world economy faltered in 2008, the demand for commodities fell. After a decade of extraordinary growth, the ETFs representing countries in the region fell sharp and fast. Though the crisis has not passed, at these lower levels Latin American ETFs deserve a look from investors.

The chart below compares the iShares S&P Latin America 40 Index ( ILF ) since its inception in 2003 with the U.S. benchmark Standard and Poors Depositary Receipts ( SPY ).

ILF was the first pan-Latin American ETF. It has an expense ratio of 0.5% and low asset turnover. ILF holds mainly companies in Mexico, Brazil, Argentina and Chile. The chart shows that ILF outperformed the SPY by 350% when it hit its peak in mid-2008. Since then the fall of ILF has been precipitous.

The most important reason for this drop is the same reason which caused the rise: the openness of regions economies and their participation in global markets. Latin American economies have been among the biggest beneficiaries of free trade and global growth. Now they face the negative side of globalization. They find themselves dependent on exports and global capital flows and therefore vulnerable to global weakness.

ILF and other Latin American ETFs also carry foreign exchange risk. For countries with floating regimes, the financial crisis brought a rapid depreciation of domestic currency, compounding the recent fall of Latin American ETFs. Currency ETFs for Mexico and Brazil: the Currency Shares Mexican Peso Trust ( FXM ) and the Wisdom Tree Dreyfus Brazilian Real (NYSEArca:BZF) are structured to track the price of the peso and real respectively. The chart below shows how the peso ( FXM ), after steadily gaining value, collapsed in September 2008.

The chart shows a 40% depreciation in the Mexican peso between August 2008 and March of 2009. Further deleveraging in the West, reduced exposure by foreign banks, and continued reduction in capital flows has inflated borrowing costs and created a domestic credit crisis.

The news is not all bad. While Latin American countries are expected to shrink in 2009, modest to strong growth is expected to return in 2010. In the foreseeable future no one projects a return to their extraordinary growth in the first part of the decade. An April 2009 IMF survey shows the following GDP growth projections for key countries of the region.

2008 2009 (est.) 2010 (est.)
Argentina 7.0 -1.5 0.7
Brazil 5.1 -1.3 2.2
Chile 3.2 0.1 3.0
Columbia 2.5 0.0 1.3
Ecuador 5.3 -2.0 1.0
Mexico 1.3 -3.7 1.0
Peru 9.8 3.5 4.5
Uruguay 8.9 1.3 2.0
Venezuela 4.8 -2.2 -0.5

2008 2009 (est.) 2010 (est.)
Argentina 7.0 -1.5 0.7
Brazil 5.1 -1.3 2.2
Chile 3.2 0.1 3.0
Columbia 2.5 0.0 1.3
Ecuador 5.3 -2.0 1.0
Mexico 1.3 -3.7 1.0
Peru 9.8 3.5 4.5
Uruguay 8.9 1.3 2.0
Venezuela 4.8 -2.2 -0.5
2008 2009 (est.) 2010 (est.) 2008 2009 (est.) 2010 (est.) Argentina 7.0 -1.5 0.7 Argentina 7.0 -1.5 0.7 Brazil 5.1 -1.3 2.2 Brazil 5.1 -1.3 2.2 Chile 3.2 0.1 3.0 Chile 3.2 0.1 3.0 Columbia 2.5 0.0 1.3 Columbia 2.5 0.0 1.3 Ecuador 5.3 -2.0 1.0 Ecuador 5.3 -2.0 1.0 Mexico 1.3 -3.7 1.0 Mexico 1.3 -3.7 1.0 Peru 9.8 3.5 4.5 Peru 9.8 3.5 4.5 Uruguay 8.9 1.3 2.0 Uruguay 8.9 1.3 2.0 Venezuela 4.8 -2.2 -0.5 Venezuela 4.8 -2.2 -0.5

ILF competes with a newer and as of now far smaller issue, the SPDR S&P Emerging Latin American ETF (NYSEArca:GML). ILF holds American Depositary Receipts (ADRs). GML, however, has holdings chosen from all publicly companies in Latin America. It therefore is more diversified, and includes representation for companies in Columbia, Peru, and Venezuela. This might be worth the extra point of expense ratio (GML has a ratio of 0.6% to ILFs 0.5%). One concern: at under 50 million in market capitalization GML is very small compared to ILF. For volume purchases Bid/Ask spreads are 10 cents or more compared to as close as a penny for ILF.

In addition to the pan-Latin American funds like ILF and GML, there are several country-specific ETFs. The largest of these are the iShares MSCI Mexico Index Fund (NYSEArca:EWW) and iShares MSCI Brazil Fund (NYSEArca:EWZ). These funds have been in existence since 2003. Both contain numerous large caps and are useful for overweighting large companies. A more recent addition is the iShares MSCI Chile Index Fund (NYSEArca:ECH). All three of these funds are designed to reflect the movement of local exchanges and provide investors with access to difficult-to-trade foreign companies.

But investors should examine individual holdings because companies held in these ETFs do not necessarily reflect all sectors of the domestic economy. About 40% of EWWs holdings, for example, are in the telecommunications sector. Though Mexico produces lots of oil, EWW holds no energy stock. The largest sector representation in the Brazilian ETF EWZ, on the other hand, (about 35%) is energy whereas just 5% of its holdings are in telecommunications. The Chilean ETF ECH also has significant energy exposure and a reatively small telecommunications position.

Jonathan Bernstein has been writing about ETFs since 2003 and is the author of Sector Trading: A Year in Exchange Traded Funds .

Jonathan Bernstein has been writing about ETFs since 2003 and is the author of Sector Trading: A Year in Exchange Traded Funds . Jonathan Bernstein Sector Trading: A Year in Exchange Traded Funds



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: ECH , EWW , EWZ , FXM , ILF , SPY

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