How To Profit From The Forthcoming Free Trade Deals

Includes: AND, C, CAT, EWY, GE, GXG, PFE
by: Efficient Alpha

By Joseph Hogue, CFA

Bloomberg reported yesterday that after more than four years and two presidents, the free trade agreements with Colombia, Panama, and South Korea have been sent to Congress for a vote. A vote about which there was much politicking and speech-making, though there was little doubt about the sufficient support for approval. Now the fast-tracked agreements must be put through for an up or down vote within 90 days. Most likely, it will take far less as Senate Majority Leader Reid said yesterday that the vote would happen within the month, and House Majority Leader Cantor is calling for a vote this week.

Though the agreement with South Korea is by far the largest, it is doubtful that even the estimated $10.9 billion boost to exports in the first year of free trade will move the needle on a sluggish economy in the red, white, and blue. It could have a more important effect on your portfolio, especially the portion devoted to emerging markets.

For investment opportunities on domestic soil, one only has to look to the companies that fought hardest to push the trade deals forward. Citigroup (C) and Pfizer (PFE) both lobbied for the South Korean deal which will see increased access to the capital markets and a growing middle class consumer. Though Citigroup’s shares will have far more pressure put on them from the unfolding global economic crisis, the opening of the South Korean market could impact revenues in the long-term.

Both Caterpillar (CAT) and General Electric (GE) have both fought for the Colombian free trade deal. Colombia and Latin America in general, has seen lower productivity growth rates over the last thirty years partly due to the lack of the capital machinery that Caterpillar and GE would love to provide. This new access to capex and capital funding was a key point I made at a recent Bloomberg conference on the integration of equity markets in Colombia, Chile, and Peru. (A summary of my argument, one that Seeking Alpha readers got before the conference, can be found in the article I posted, “First Mover Advantage on the Bloomberg MILA Conference.”)

For more generalized investments directly in these markets, investors should look to emerging market ETFs or specific country funds. Both the Colombian and South Korean markets benefit from an increase in consumer spending, something the developed markets are sorely lacking.

The Global X FTSE Colombia 20 (GXG) holds the 20 most liquid stocks on the Colombian market and charges an expense ratio of .68%. The fund is also highly concentrated but reflects the local market with: financials (41.2%), energy (17.1%), industrials (10.7%), utilities (9.6%), and materials (9.0%). The average price to book value of the fund is 2.6 and has lost 7.1% of its value over the last twelve months.

Given possible performance in the MILA markets, and as a way to diversify away from a single country fund but maintain some exposure to the Colombian market, investors may look at the Global X FTSE Andean 40 (AND). The Andean fund holds the 40 most liquid equities in Chile, Colombia, and Peru and charges an expense ratio of .72%. The fund tracks the new MILA exchange closely with country weights of Chile (51.0%), Colombia (33.4%), and Peru (15.5%). Sector exposure also mimics the integrated exchange, though with some tracking risk, with: materials (26.4%), financials (24.3%), consumer goods (12.6%), utilities (12.4%), energy (12.0%), and industrials (10.2%).

The iShares MSCI South Korea Fund (EWY) tracks the publicly traded securities in the South Korean market through the MSCI Korea Index. The fund holds 105 securities and charges an expense ratio of .61%. The fund is well diversified across sectors with: information technology (24.2%), consumer discretionary (18.5%), industrials (16.1%), financials (15.0%), materials (14.7%), and consumer staples (4.7%). As of the end of last month, the fund had a price-to-earnings ratio of 14.5 times.

While events in Europe and a sluggish economy in the U.S. will certainly influence the stock prices in these markets, one has only to look at their relative performance since 2009 lows to see the investment opportunity. Both the Colombian and South Korean funds rebounded quickly from the recession and have beaten the S&P500 by 94% and 35%, respectively. This theme is not restricted to just these two countries. I wrote an article a couple of months ago showing how emerging market funds may outperform the S&P given a recession. These emerging markets are still tied to the U.S. and Europe through exports and basic materials, but they are developing their own consumer class and have a very high level of reserves to help them through a few tough years.

Disclosure: I am long AND.