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Research has shown that investors have a home market bias, perhaps with good reason, perhaps not. However, some investors turn to emerging markets to better diversify their equity portfolios. The rationale is that the emerging markets offer better diversification than other mature markets. However, since so many investors are going through the same thought process and reaching similar conclusions, quite a bit of money flows into the same emerging markets. When U.S. investors feel good, more money flows and when U.S. investors become concerned or panicked, the money then flows back out. Furthermore, the constant globalization and increasing interconnectedness increases the correlation of these emerging markets to the U.S. During the 2008 financial crisis, pretty much all markets correlated together and declined together.

This article will review widely available Brazilian ETFs and American Depository Receipts (ADRs) to identify the ones with the lowest correlation to SPDR S&P 500 Trust ETF (SPY). However, it should be noted that the securities with the lowest correlations might not be truly reflective of the Brazilian market as a whole. The following securities were checked:

Brazilian ETFs and Stocks

Ticker

Name

Assets or Market Cap ($ Billions)

Sector

PBR

Petroleo Brasileiro SA

253.5

Energy

VALE

Vale SA

167.7

Mining

ITUB

Banco Itau Holding Financeira SA

98.8

Banking

ABV

Companhia de Bebidas das Americas

83.1

Consumer Products

BBD

Banco Bradesco SA

70.8

Banking

BSBR

Banco Santander SA

43.7

Banking

SID

Companhia Siderúrgica Nacional

22.9

Steel

VIV

Vivo Participações S.A

14.3

Telecom

EWZ

iShares MSCI Brazil Index

12.7

ETF

CIG

Companhia Energetica de Minas Gerais – CEMIG

12.0

Utility

CBD

Compannhia Brasileira de Distribuicao

10.3

Retail/Grocery

BAK

Braskem S.A.

9.9

Chemicals

TSU

TIM Participacoes S.A.

9.6

Telecom

UGP

Ultrapar Ptp

8.5

Energy

ELP

Companhia Paranaense de Energia – COPEL

7.2

Utility

ERJ

EMBRAER - Empresa Brasileira de Aeron

6.2

Aircraft

TNE

Tele Norte Leste Participacoes S.A.

6.1

Telecom

SBS

Companhia de Saneamento Basico do Estado de Sao Paulo

6.1

Utility

BTM

Brasil Telecom S.A.

4.7

Telecom

GOL

GOL Linhas Area

3.6

Airlines

PZE

Petrobras Energia Participaciones S.A.

2.2

Energy/Chemicals

BRF

Market Vectors Brazil Small-Cap ETF

0.9

ETF

BRAF

Global X Brazil Financials ETF

$9 million

ETF

BRXX

EGS INDXX Brazil Infrastructure ETF

$77 million

ETF

EWZS

MSCI Brazil Small Cap Index Fund

$48 million

ETF

BRAZ

Global X Brazil Mid Cap ETF

$30 million

ETF

BRAQ

Global X Brazil Consumer ETF

$30 million

ETF

UBR

ProShares Ultra MSCI Brazil Fund

$13 million

ETF

Source: Yahoo!Finance

I looked at the correlation to SPY over a couple time frames. Some of the ETFs are very new and lack sufficient history. I did not consider securities with less than 24 months of trading history.

Correlations to SPY

Ticker

24 Month Correlation

60 Month Correlation

Correlation 1/06-6/08

SPY

100.0%

100.0%

100.0%

VALE

81.8%

67.6%

54.8%

EWZ

80.8%

76.0%

59.4%

ITUB

78.2%

77.4%

63.1%

ERJ

77.0%

79.0%

40.0%

BBD

76.0%

71.9%

55.8%

VIV

73.4%

47.5%

48.4%

SID

72.7%

NA

NA

PBR

69.0%

55.9%

35.1%

TSU

61.7%

41.8%

44.3%

UGP

59.5%

55.2%

40.6%

GOL

59.0%

58.0%

44.7%

ABV

56.1%

65.0%

39.8%

SBS

55.9%

64.5%

40.6%

ELP

49.6%

50.1%

39.9%

BAK

49.4%

55.0%

33.9%

TNE

48.5%

40.8%

-3.0%

BTM

44.9%

52.7%

36.5%

CIG

40.3%

45.5%

48.2%

CBD

25.3%

38.8%

16.5%

PZE

14.6%

31.9%

39.6%

Source: Yahoo!Finance for monthly split and dividend adjusted prices.

The first observation is that correlations over the past 2 years are generally higher than the correlations prior to the financial crisis. It is not clear if this simply represents a short trend or if all securities are becoming more correlated. For example, the leading Brazil ETF, EWZ, has a full 80% correlation to SPY while prior to the crisis it was just under 60%. I noted in an earlier article that this trend was occurring across all markets.

Returns

Perhaps most importantly – or perhaps what you’ve been thinking – how have these stocks performed in terms of returns? I looked at gross total return. By gross, I mean that the return is not annualized and total means that dividends are included. So you can see that for SPY, a 3 year return of 2.6% reflects share price depreciation since there were more than 2.6% worth of dividends over 3 years.

Total Returns

Ticker

1 Year

2 Year

3 Year

4 Year

SPY

11.0%

65.8%

2.6%

7.7%

BAK

71.1%

503.2%

46.0%

75.8%

ABV

52.6%

206.3%

103.3%

183.0%

SBS

45.3%

154.9%

24.8%

63.7%

TSU

44.0%

234.3%

32.0%

34.5%

ERJ

42.8%

157.7%

-12.8%

-23.7%

PZE

34.9%

312.0%

114.2%

139.7%

UGP

34.6%

184.7%

100.8%

142.0%

VIV

31.6%

183.8%

60.5%

172.5%

BTM

31.4%

51.3%

-23.5%

71.4%

ELP

28.7%

161.9%

73.2%

153.8%

CBD

20.8%

203.3%

101.8%

186.9%

BRF

20.0%

NA

NA

NA

BRXX

12.2%

NA

NA

NA

CIG

10.5%

62.4%

39.6%

55.2%

GOL

7.1%

384.3%

-7.4%

-54.3%

EWZ

2.7%

108.9%

7.6%

70.9%

BBD

2.7%

92.3%

3.9%

45.5%

VALE

2.1%

153.1%

0.1%

88.3%

ITUB

-0.3%

102.5%

21.9%

59.9%

BSBR

-5.3%

NA

NA

NA

TNE

-10.1%

23.1%

-35.5%

23.6%

PBR

-12.1%

30.1%

-22.2%

60.8%

SID

-18.7%

118.8%

-1.9%

NA

Source: Yahoo!Finance for monthly split and dividend adjusted prices.

So over the 1 year period, over half the securities outperformed the SPY. Over a 2 year period, all but 2 securities outperformed. However, looking at the 4 year returns it is interesting to note that there are some securities that are down. This shows the volatile nature of stock picking and should be a warning that just randomly buying Brazilian securities with low correlations to SPY does not make them good investments. The other observation is that EWZ underperformed the SPY over the past year. Extending this observation is that the underperformers were the larger stocks, including 6 of the 7 largest stocks that I reviewed. Not only that, but these large caps seem to trail the smaller companies across all 4 time periods. The only exception was ABV.

Conclusion

So what do I take away from all this number crunching that is completely devoid of any fundamental analysis?

First, to me it is slightly eye opening that the smaller stocks seem to be outperforming the larger stocks with the last year being a very glaring example. What are the reasons behind this? Will it continue?

Second, I’m rethinking my investment approach to Brazil. While I’m currently long EWZ and generally bullish on Brazil (largely because of overall fundamentals and growth prospects), adding more exposure through small caps and mid caps ETFs might provide more diversification and better upside. Many large cap stocks in Brazil are commodity or financial plays. I will definitely look closer at BRF, EWZS and BRAZ. BRF is more intriguing since BRAZ has just $30 million of assets and EWZS is at $48 million. BRF has just under two years of history. But over that time frame it shows a slightly lower correlation than EWZ at around 65% versus 80%. While its monthly volatility is 8.6% noticeably higher than SPY, it is just a little higher than EWZ at 8.0%.

Third, CBD looks like an interesting company to research further. It caught my attention because of its low correlation and solid returns. It is also in the retail industry, which means it is not driven by commodity prices. CBD has a $10.3 billion market capitalization so it is not small, but clearly not large yet either. I think it is certainly worth a closer look.

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. I am long EWZ and SPY.

Source: Looking for Better Brazilian Diversification