Brazil ETFs: Best of the BRIC

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 |  Includes: BRF, BRXX, EWZ
by: Eric Dutram

Over the past decade, investors have piled into investment vehicles that track the so-called BRIC countries of Brazil, Russia, India, and China. These economies have generally been very good to investors, with many BRIC-focused funds producing solid gains over the years that have far outpaced more developed markets. However, not all of the BRIC building blocks were created equal, with each offering their own unique risks and rewards. While some might argue that investors would be better served by investing in a different set of countries in order to achieve optimal international exposure (see Forget The BRIC Your Portfolio Needs The TICK), it is hard to argue that a group of countries that combines to make up nearly 40% of the world’s population will not have a huge impact on the world economy.

The debate often rages on which BRIC bloc will soar the highest. The case for China is a relatively easy one to make, while arguments for a potential surge in the importance of India hold some water as well. Brazil is often overlooked in favor of its Asian counterparts, but this South American growth engine may be the best of the BRIC for three reasons; resources, demographics, and geographic location. This unique combination of strengths is in many ways what made America the dominant power of the late 20th century. Brazil could be destined for the same remarkable rise if it catches a couple breaks and takes full advantage of its fortuitous position in the world (see the Definitive Guide To BRIC ETF Investing).

Resource Powerhouse

While Russia has ample oil and natural gas reserves, Brazil’s mineral and agricultural output is virtually unparalleled in the world. The country is the leading producer of beef, poultry, pork, ethanol, coffee, orange juice concentrate, sugar, and tobacco. In addition, Brazil has seen farm exports grow an average of 20% a year since 2000, according to the USDA. The country has also found significant oil deposits and has achieved complete energy independence, suggesting that the country will be better insulated from energy shocks and food price spikes than some of its other BRIC counterparts. China, for example, relies heavily on Australia, Brazil, and a handful of other suppliers to fuel its insatiable appetite for raw materials.

Demographics

Of the four BRIC countries, Brazil arguably has the demographic profile most favorable to economic growth. The country has a relatively stable population that is growing at a slightly higher rate than the world average. Meanwhile, Russia’s population is expected to halve within the next fifty years, as the combination of a low birth rate and already short life spans dramatically reduce the once surging population. China is also facing growing concerns over its aging population. Moreover, the effects of its one-child policy (which in addition to the cultural preference for male children, has led to one of the largest disparities in the male/female ratio in the world) present an obstacle to long term growth (albeit not one that cannot be overcome).

India has more favorable demographic trends, but massive wealth gaps somewhat limit the effect of increases in population, and the sheer size of the country makes achieving developed status a tremendous challenge. In many ways Brazil is in a demographic sweet-spot; its country has a large enough population to make a difference on the world stage, but it isn’t too large, which would make it impossible to grow the country into a first world nation (as evidenced by the big focus on infrastructure development).

Geographic Location

Brazil, much like the United States, benefits from its geographical location – sheltered by oceans from potential rivals. While China must compete with bordering Russia and India, in addition to nearby powerhouses Japan, South Korea, and Taiwan and rising stars in Southeast Asia, Brazil competes with the likes of Bolivia and Venezuela, two countries that are quickly falling behind economically. Furthermore, since it is so much larger, both in terms of population and GDP, it seems likely that Brazil will remain the dominant regional power for quite some time no matter how quickly the country grows.

Brazil ETF Options

There are currently several options available to investors who are seeking Brazilian exposure, including the small-cap Brazil ETF (NYSEARCA:BRF) and a fund that invests in infrastructure companies in Brazil, the Brazil Infrastructure Index Fund (NYSEARCA:BRXX). And then there’s the $11 billion iShares MSCI Brazil Index Fund (NYSEARCA:EWZ), which trades close to 11 million shares a day. EWZ has a heavy focus on the energy and materials sectors, which combine to make up more than half of the fund. This ETF is significantly underweight information technology and industrials, which combine to make up roughly 5% of total assets.

EWZ charges an expense ratio of 0.63%, and it just above break-even in 2010 (but it has produced a return of 63% over the past year). EWZ also has a relatively long track record of growth; even after the recent financial crisis, the fund has delivered an average annual rate of return of 30% for the past five years (for more information about alternatives to EWZ make sure to check out BRF Is A B-U-Y).

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Click to enlarge

Risks Remain

There are, of course, risks to any investment, and the future is not entirely bright for Brazil. The country has a high crime rate, relatively unskilled population and an undiversified manufacturing sector. In addition, Brazil has a literacy rate below 90% and more than one-fourth of the population lives below the poverty line. Current President Luiz Inácio Lula da Silva is set to step down at the end of the year, and there is some question as to who will replace him as the leader of the country. The country also suffers from severe corruption, which has hampered growth in recent years (see Seven Most Corrupt Country ETFs). Despite these issues, Brazil still could offer the best possible risk/reward profile out of all the BRIC countries and could warrant a closer look from investors with a little appetite for risk.

Disclosure: Eric is long EWZ.