A Look at Latin American ETF Investment Options

by: Bennington Investment Ideas

While Latin America investing is often focused on the more recognized Brazil and Mexico ETFs and in particular iShares MSCI Brazil (NYSEARCA:EWZ) and iShares MSCI Mexico (NYSEARCA:EWW), there are several other investment opportunities stretching across other nations. This article will highlight some of the other available ETFs and their countries of origin.

Latin America is a large, but in some ways fragmented economic block. Latin America encompasses Mexico through Central America and into South America with a population of close to 600 million spread across 20 countries. From an economic perspective, there are several splinters since Mexico is part of the North American Free Trade Agreement. Some additional trading blocks are the Union of South American Countries and CARICOM, comprised of the Caribbean countries. Some additional countries have free trade agreements with the United States.

This article will focus on the following countries and their associated ETFs. While additional mutual funds could provide added diversification or investment opportunities, I'll just focus on ETFs. Additionally, one could purchase several individual stocks on U.S. exchanges.

Latin American Country ETFs
Ticker Name Assets ($ Millions) Yield P/E
EWZ iShares MSCI Brazil Index 12,690 3.8% 10x
EWW iShares MSCI Mexico Investable Market Index 1,480 0.9% 15x
ECH iShares MSCI Chile Investable Market Index 873 0.7% 22x
EPU iShares MSCI All Peru Capped Index 678 1.8% 10x
GXG Global X/InterBolsa FTSE Colombia 20 ETF 136 0.7% 8x
Source: Yahoo!Finance downloaded on March 16, 2011 and current as of download date.

Global X FTSE Argentina 20 ETF (NYSEARCA:ARGT) just began trading earlier this month and so has limited data available, but would also represent a good opportunity, especially as one of the larger economies in Latin America.

One should note that while these ETFs create significant financial and basic materials exposure, the sector allocations among the countries shows meaningful variation as noted below.

Sector Allocations
Basic materials 26.5% 20.9% 19.8% 67.4% 0.8% 2.9%
Consumer cyclical 3.3% 9.7% 8.4% 0.0% 0.0% 9.3%
Financial services 20.5% 8.4% 10.1% 19.6% 45.8% 14.9%
Real estate 2.5% 0.9% 0.0% 0.0% 0.0% 1.6%
Consumer defensive 4.7% 24.1% 3.4% 2.7% 0.0% 10.6%
Healthcare 0.9% 0.0% 0.0% 0.0% 0.0% 10.7%
Utilities 3.8% 0.0% 25.2% 2.5% 0.0% 3.1%
Communication services 2.3% 28.1% 0.0% 0.0% 0.0% 4.2%
Energy 30.7% 0.0% 21.9% 3.4% 53.4% 12.9%
Industrials 4.4% 7.9% 9.7% 4.3% 0.0% 12.7%
Technology 0.3% 0.0% 1.5% 0.0% 0.0% 17.2%
Source: Yahoo!Finance downloaded on March 16, 2011.

The first observation is that these countries lag the U.S. in technology and healthcare exposure but generally lead the U.S. in exposure to basic materials and energy. For example, EPU has almost 70% of its exposure to basic materials. This creates a very different set of investment issues than Mexico which is less concentrated. For example, an investor concerned about rising inflation might be more attracted to EPU.

Some glaring sector exposure differences also highlight the issue of concentration risk. The top three holdings in SPY represent around 8% of the assets, while the top three holdings in GXG are almost 50%, in EWZ almost 30%, and over 40% for EPU. At this level, it is very worthwhile to examine each of the individual companies. While at first glance, it might seem advantageous to simply create your own portfolio of individual companies since many major companies have American Despository Receipts. However, this would eliminate exposure to smaller growing companies that should develop as these markets grow and mature over time.

This economic development can further be seen by reviewing the equity market capitalizations within these countries relative to economy size.

Market Size to Economy Size
Country 2010 Total Equity Market Capitalization ($ millions) 2010 GDP (PPP basis) ($ millions) Ratio # of Companies Average Size ($ millions)
Chile $ 341,799 257,546 132.7% 231 1,480
United States $ 17,283,452 14,624,184 118.2% 5,095 3,392
Brazil $ 1,545,566 2,181,677 70.8% 381 4,057
Colombia $ 208,502 429,866 48.5% 86 2,424
Peru $ 103,348 274,276 37.7% 248 417
Mexico $ 454,345 1,549,671 29.3% 427 1,064
Argentina $ 63,910 632,223 10.1% 106 603
Source: Number of companies and traded market capitalization are from World Federation of Exchanges. GDP figure are from International Monetary Fund. Data was downloaded on March 17, 2011.

While Chile appears to have significant market capitalization, the other countries lag the U.S. One observation is that its Price to Earnings ratio in its ETF is substantially higher than the other's. However, there are numerous potential reasons for why this might be the case. At the highest level, a low ratio suggests opportunities for growth and development. However, it could also be indicative of systematic challenges to the formation of larger companies. One aspect that is important to separate out from this ratio is whether the total market capitalizations are increasing due to share issuances from established or new public companies or from share appreciation at existing companies. Ideally, it would be from a mix of both.

While the larger market ETFs, such as EWZ and EWW offer limited diversification to SPDR S&P 500 Trust ETF (NYSEARCA:SPY), the smaller Latin American countries offer much lower correlations as noted below.

Correlation to SPY
Ticker 7/2009 - present 12/2007 - present
SPY 100.0% 100.0%
EWW 90.2% 88.4%
ILF 85.3% 84.4%
EWZ 80.7% 79.8%
EPU 69.9% NA
GXG 46.3% NA
ECH 29.7% 51.8%
Source: Yahoo!Finance for split and dividend adjusted monthly closing prices.

Led by Brazil and Mexico, Latin America offers significant investment opportunities and provides added diversification to a portfolio primarily focused on the U.S. However, further analysis would be critical prior to making an investment decision.

For investors not interested in picking countries, there is the recently launched Global X FTSE Andean 40 ETF (NYSEARCA:AND) and the more established iShares S&P Latin America 40 Index (NYSEARCA:ILF). For investors seeking greater diversification, I would suggest ECH, EPU, and GXG. More focused investors can look for individual companies.

A more detailed fundamental analysis of the countries' policies, restrictions on capital and general macro economic conditions would be valuable prior to making an investment decision. The purpose of this article was to simply identify some options. Furthermore, there are many more focused ETFs within the larger markets such as Brazil and Mexico. I've identified some of the other Brazil options here.

Disclosure: I am long SPY, EWZ.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.