Investing in South Africa via EZA - and Other Options

Below is the argument supporting last Friday's ETF Pick of the Week.

South Africa (EZA) is a major logistical trading center for oil and other resources and home to aggressive and sophisticated multinationals that are seeking opportunities throughout the continent. Talent and capital are attracted to its role as a beachhead for seeking opportunities throughout the region. South Africa is home to ports through which OPEC oil is transported to the U.S. and also through which African oil is transported to China and India.

South Africa is geographically and strategically placed to mine and transport the world’s most precious commodities. Commonly thought of a gold play, mining is big business in South Africa and therefore it is no surprise that materials production is leading the recovery. Materials, in fact, account for the largest portion (27.53%) of the iShares MSCI South Africa Index Fund (EZA).

The second largest portion (24.54%) of EZA’s holdings might surprise you - financials. As strange as it may seem for an emerging market, South Africa’s banking industry is one of the worlds most stable. Even as banks across the world were crumbling South Africa’s banks have stood tall.

EZA has good momentum and has posted a total YTD return 32%. It can be volatile with the top ten holdings of EZA accounting for 62% of its assets. Its currency is strong even as South Africa’s Reserve Bank has decreased interest rates to an all-time low. Since March, the South African rand has surged 36% against the dollar as its deficit shrank to a four year low of 4.3% of GDP in the second quarter. In addition, Political risk has receded somewhat though unemployment remains stubbornly high and crime in urban areas at unacceptable levels.

Perhaps this is why the WisdomTree Dreyfus South African Rand Fund (SZR) has enjoyed consistent growth since its inception. This currency ETF is slightly less volatile than EZA yet still boasts amicable growth patterns, making it a welcomed long-term holding. The YTD total return on NAV is 23.02% and share price is 25.94%. Not as large as EZA’s returns, but still plenty of room for growth. Another currency ETF with some exposure to the rand is WisdomTree's newest currency ETF, the Emerging Market Currency Fund (CEW), which done well so far.

Catalyst: With gold performing better, technical factors pointing to good prospects going forward and many using gold ETFs as a hedge against global financial instability, EZA will get attention as an indirect play on this sector. It is also perhaps the best way to play the ample economic opportunities on the continent.

Risk Factor: The risk factor is high and EZA can be volatile. Suggest small position and trailing 6% stop loss.

Tip: For broader exposure to African opportunities and the risks that go with it, consider AFK.