The Uphill Battle Facing Mexico ETFs

The segment, populated by five different ETFs, is mired in fundamental challenges, rising political tension and mixed investment signals.

Mexico equity ETFs haven’t been able to catch a break since early November 2016 when Donald Trump was elected president. And the outlook for these funds going forward is neutral at best in the face of various emerging trends.

In the week following the election, the largest of the U.S.-listed Mexico ETFs, the iShares MSCI Mexico Capped ETF (EWW), plunged nearly 15% in five days. For perspective, up until the day before the election, EWW had tacked on gains of more than 5% in 2016. The fund was chugging along higher, riding the same wave of recovery that emerging market ETFs were benefiting from.

EWW has yet to recoup most of those losses incurred in the days following the Trump victory.

In the past 12 months, EWW has been a clear underperformer relative to a broad basket of emerging market equities, measured by the iShares MSCI Emerging Market ETF (EEM), and the S&P 500, via the SPDR S&P 500 ETF (SPY): 

What Investors Need To Consider

As an investor, there’s a lot to consider when weighing the pros and cons of an allocation to Mexico equity ETFs today.

From a political standpoint, tension is rising between the U.S. and Mexico. The latest news that President Donald Trump is mulling over a 20% import tariff on Mexican goods aimed at funding the “wall” he wants to build between the U.S. and Mexico to deal with illegal immigration is weighing on the outlook for these ETFs. Geopolitical risk is real here.

The proposed wall is said to have a price tag of $20 billion, and the issue is so contentious, Mexico’s President Enrique Pena Nieto this week canceled his upcoming meeting with Trump, according to CNN.

From an investment perspective, Mexico is a “complicated situation” right now, according to Dave Garff, head of Accuvest, a Walnut Creek, California, firm that specializes in single-country investing.

Tough Times Ahead For Mexico

“Most of the local businesspeople think there are difficult times ahead, for the peso as well as business in general,” he said. “A Trump presidency is certainly something that will cause problems for Mexico, whether it’s a wall or tariffs or something we haven’t even considered yet.”

Garff elaborated: “Mexico’s challenge goes beyond the ongoing feud with President Trump. A budget in the red amid oil price weakness, and mounting social and economic divisions in an environment where most distrust government and institutions, all point to the possibility that 2018 elections in the country will result in a left-leaning administration. That would certainly make foreign investors think twice about taking—or keeping—positions in Mexico.”

The fundamental picture is also mixed, making a “neutral” position in Mexico possibly the best bet at the moment, he adds.

Here are three key data points to consider, according to Accuvest research:

• The Mexican peso is likely to appreciate 2-4% from current levels despite a lot of talk to the contrary.
• Fundamentals are “about average” relative to the rest of the world. “Strong earnings growth is being tempered by contracting PMI levels.”
• Valuations are high. “Mexico is expensive relative to the rest of the world” in just about every metric of value.

“If Trump turns down the rhetoric, and oil prices stabilize and move higher, Mexico could represent an interesting investment,” Garff noted. “We just aren’t there yet.”

Picking A Mexico ETF

In the ETF space, there are five Mexico total market ETFs available to investors.

But the segment really offers little choice if you consider that four of these funds are incredibly small in terms of assets.

Two of them are currency-hedged plays: the Deutsche X-trackers MSCI Mexico Hedged Equity ETF (DBMX) and the iShares Currency Hedged MSCI Mexico ETF (HEWW).

And two of them are leveraged/inverse strategies: the ProShares Ultra MSCI Mexico Capped IMI (UMX) and the ProShares UltraShort MSCI Mexico Capped IMI (SMK).

EWW is really the only vanilla, market-cap-weighted portfolio of Mexico stocks, and the cheapest, most liquid to boot, making it the clear leader in this space with $1.8 billion in assets.

Still, know what your options are. Here are the ETFs in this segment at a glance: 

From a performance standpoint, hedging out currency exposure has paid off in the past year in the face of ongoing U.S. dollar strength.

Look at the numbers in the chart below—EWW is flat, while HEWW and DBMX are up significantly. 

Currency-Hedging Angle

In the currency-hedged space, HEWW invests in EWW for its equity exposure, and uses one-month forward derivatives to hedge out the currency.

DBMX isn’t that different. It’s built around the MSCI universe of Mexican equities, and hedges out currency via derivatives. But DBMX enjoys the benefits of being first-to-market, enjoying a larger asset base.

If Mexico’s peso does, in fact, appreciate from current levels, these two funds would suffer relative to EWW because they tend to underperform when the dollar weakens.

Leverage/Inverse Angle

UMX is designed to offer 200% of the daily performance of the MSCI Mexico IMI Index, which is a market-cap-weighted total Mexico market index.

The biggest challenge with this fund is its lack of liquidity. Meant to be used as a tactical trading vehicle held for one day at a time, UMX’s “value proposition” is challenged by the fund’s lack of liquidity “with weak daily volume and volatile spreads,” according to ETF.com analytics.

The same can be said about SMK. This ETF offers twice the inverse daily performance of the index. In theory, the fund is the perfect vehicle for investors looking to bet against Mexico’s equity market, but “despite tracking a well-designed benchmark, SMK is almost untradeable,” ETF.com data show. “It simply doesn’t trade on most days. When it does trade, it has prohibitively wide spreads.”

The chart below shows how these two ETFs have fared relative to EWW in the past 12 months: 

Charts courtesy of StockCharts.com

Picking the right ETF for your portfolio depends on your goals. The choices in this segment are clearly limited.

And if you are unsure whether it makes sense to express strong views on Mexico one way or the other because the situation seems fluid in the early days of a new administration in the U.S., there’s always the option of minimizing single-country risk by owning exposure to Mexico via broader emerging market funds.

If you own EEM, for example, you have a 3.5% allocation to Mexico within that fund. EEM is linked to MSCI’s view of the world—the same view underlying EWW and HEWW. If you own the Vanguard FTSE Emerging Markets ETF (VWO), linked to FTSE’s take on the emerging market space, you’d be 3.8% allocated to Mexico within that fund.

There’s more than one way to access Mexico’s market via ETFs.

Contact Cinthia Murphy at [email protected]