Reform can do wonders for an emerging market equity portfolio. Just take a look at the ongoing rally in Brazil ETFs.
Through the end of September, many of these funds had been struggling to find much upside year-to-date. So far, 2018 has been a tough year for emerging markets in general, and to Brazil specifically—a country that has struggled economically and politically amid various corruptions scandals.
The largest ETF in this segment, the $6.7 billion iShares MSCI Brazil ETF (EWZ), was down about 3%, while its small-cap counterpart, the iShares MSCI Brazil Small-Cap ETF (EWZS), was down more than 14%. Other ETFs in this space include funds like the Franklin FTSE Brazil ETF (FLBR) and the First Trust Brazil AlphaDEX Fund (FBZ).
Summer Blues Turn To October Hope
Then, October rolled around, and a much-anticipated presidential election took place on Oct. 7. That vote yielded a significant lead for far-right candidate Jair Bolsonaro, who now battles the second-most-popular candidate, left-leaning Fernando Haddad, for a simple majority in a second runoff vote on Oct. 28.
Bolsonaro, formerly in the military, is largely considered a pro-reform, market-friendly candidate who some say could help Brazil’s ongoing economic recovery.
Tackling Debt Problem
In a recent blog exploring the investing implications of Brazil’s presidential election, BlackRock’s Chief Multi-Asset Strategist Isabelle Mateos y Lago said the following:
“Bolsonaro has promised to tackle Brazil’s debt problem through pension reform, halving the number of government ministries, and extending privatizations. A Bolsonaro administration would need congressional support to tackle such a reform agenda. Gaining such support would be no easy task given the 35 parties in Brazil’s political system, but Bolsonaro’s party had a stronger than expected showing on Sunday, becoming the second largest party in the lower house.
“A victory by Haddad–who represents the Workers’ Party (PT)–could spark market fears that he would be more hesitant to press on with the fiscal consolidation process started by the outgoing government. Haddad’s proposals include capital controls and a roll-back of reforms including privatizations.”
According to Newsweek, the latest polls from Datafolha and Ibope show Bolsonaro in a neck-and-neck race. Prospects of a Bolsonaro win have been fueling the rally in Brazil ETFs throughout October.
So far this month, EWZ has tagged on gains of 15%, while small-cap EWZS is up almost 16% since Oct. 1. Two other Brazil ETFs landing among top performers in the past month are FLBR and FBZ.
Charts courtesy of StockCharts.com
At a glance, here are the main differences between these four portfolios, all of which are among the month’s top-performing ETFs:
- EWZ is the segment leader, with $6.7 billion in total assets and a live track record that dates back to its July 2000 inception. The vanilla, market-cap-weighted MSCI-linked portfolio is hugely liquid, trading on average more than $1 billion a day at spreads averaging 0.03%. The portfolio is surprisingly small, with only about 50 holdings, but weighted average market cap sits at $33.5 billion—these are Brazil’s largest companies. EWZ costs 0.62% in expense ratio, or $62 per $10,000 invested.
- FLBR tracks a market-cap-weighted index of Brazil’s large- and midcap stocks in a portfolio that isn’t as large as some of its competitors due in part to liquidity requirements. FLBR currently owns 70 holdings, with a weighted average market cap of $35.5 billion. With $12.3 million in total assets, the one-year-old fund is still pretty young and small, trading on average just under $72,000 a day. But it’s very competitively priced at 0.19%, or $19 per $10,000 invested—less than a third EWZ’s price tag.
- FBZ uses a multifactor selection approach and tracks a tiered index that seeks companies poised to outperform the market. The portfolio tilts toward mid- and smaller-cap names as a result. The weighted average market cap of its 49 holdings is only about $8.2 billion—that’s a quarter of FLBR’s average market cap. FBZ is still tiny, with only $7.8 million in total assets, trading about $196,000 a day, on average. The fund isn’t cheap. It costs 0.80% in expense ratio, or $80 per $10,000 invested.
- EWZS is a vanilla small-cap portfolio, tracking an MSCI market-cap-weighted index. Of note here is the fact that more than 90% of EWZS' portfolio is invested in only five sectors: industrials, consumer cyclicals, non-cyclicals, utilities and financials, according to our data. That’s not a deliberate bet, but a reflection of Brazil’s investable small-cap market. EWZS has been around since 2010, but still doesn’t have much of a following, with only $53 million in total assets. The portfolio has a weighted average market cap of $1.3 billion—these are small companies—and costs 0.62% in expense ratio.
What’s Next For Brazil ETFs?
Going forward, all eyes will be on the outcome of the second and final vote on Oct. 28, when a new president should be elected by a simple majority.
“Brazilian assets’ longer-term prospects will hinge on the new government’s ability to implement reforms,” BlackRock’s Mateos y Lago said. “The Brazilian economy remains in a fragile state despite recovering from a 2015-2016 recession.”
Contact Cinthia Murphy at [email protected]