The Deutsche X-trackers MSCI Mexico Hedged Equity ETF: A New World Leader?

| About: Deutsche X-trackers (DBMX)

Summary

70% of Mexico’s bilateral trade is with the world’s leading economy.

Mexico’s central bank maintains a disciplined policy determined to avoid past mistakes.

The government has made great progress but still has a tough, uphill fight against poverty and corruption.

Over the past decade the Mexican economy has been over shadowed by the emerging market economy of Brazil. Indeed, Brazil had even held a position in the exclusive 'BRIC' club. Over the past year the commodity market collapse, excessive public service spending, out-of-control inflation, sovereign debt rating downgrades, allegations of corruption and political scandal have eroded the foundation of Brazil to the point of economic collapse. Mexico has also struggled with commodity prices and a weakening global economy, but Mexico has several strategic advantages. First and foremost, Mexico is also a member of an exclusive club: NAFTA. Through its membership, Mexico has near exclusive access to the seemingly insatiable American and Canadian consumer markets and visa-versa. Further, Mexico has an innovative central bank, Banco de México, presided over by Agustin Carstens. Realizing that well over 70% of traded was destined for and over 52% of trade originated from its NAFTA partners, the bank concentrated on two critical factors. First, maintaining a 3% or less annual inflation target and second, maintaining a trade exchange parity with the US dollar. It has accomplished these tasks by, first, keeping its overnight deposit interest rate target at 3.25%, sufficient for keeping inflation within target. Second, the bank maintains a 'ceiling' on the US Dollar Mexican Peso exchange rate by regularly selling Dollar reserves and purchasing Pesos. This strategy keeps inflation contained domestically and at the same time maintains a trade purchasing parity with its NAFTA partners.

Data from Deutsche Asset & Wealth Management

Mexico's GDP is respectable at $1.8 trillion (USD) ranking it 15th globally; it has a slow but positive growth rate of 1.1% annualized, 1.8% when compounded annually over five years; a 5.0% unemployment rate and the average per capita income is approximately $16,750, around 68th of nearly 200 nations. Poverty is an issue in Mexico. According to the World Bank about 51% of Mexican citizens live below the poverty line. Mexico's economy also attracts billions of dollars in foreign capital investment from companies like PepsiCo (NYSE:PEP), Cisco (NASDAQ:CSCO), Ford (NYSE:F), Nissan (OTC: OTCPK:NSANF) and Nestle (OTC: OTCPK:NSRGF), just to name a mere few. However, wages remain extremely low, averaging about $2.43 per hour. Lastly, a large portion of Mexico's economy is 'off-the-books'. Naturally this brings to mind the illegal drug trade cartel insurgency with at least 164,000 documented civilian casualties between 2007 and 2014; nearly eight times more than civilian casualties in Afghanistan and twice as many in Iraq over the same period. However, under the leadership of President Enrique Peña-Nieto the government is regaining control using highly trained and well equipped special forces.

According to the Heritage Foundation's 2015 Index of economic freedom, Mexico receives a 'moderate' ranking of 66.4; about midway, globally. In particular it is noted that

...improvements in three of the 10 economic freedoms, including freedom from corruption and labor freedom, offset by declines in the management of government spending, fiscal freedom, and business freedom... ...Deteriorations in the fiscal and regulatory environments have occurred in an environment of slow economic growth despite a reform-minded leadership bent on increasing competition and opening the economy to trade and investment... ...economic performance remains far below potential...

This last point is of key importance for the potential investor. The government is pro-reform, the central bank is maintaining financial stability and the military is regaining control from the cartels. Thus the economy has the potential to far exceed its historical economic growth and quality of life for its citizens.

Lastly, it needs to be noted that Mexico is a major oil producer and the US a major importer of Mexican oil. Mexico's main competitor in the region naturally is Canada. However, it isn't as much a demand issue as it is a price issue. In mid-December, Mexico successfully auctioned off all 25 onshore fields in spite of the current global oversupply of crude oil; the winners included foreign as well as domestic companies. This bodes well for the future, but the collapse of oil prices has reduced government revenues by 38% year over year.

When the entire landscape is taken into account, it reasonable to conclude that on one hand, Mexico is in many ways an emerging market, particularly when it comes to wages, poverty, law enforcement and alleged corruption. On the other, the emerged portion of Mexico's economy is sophisticated, well managed, attracting foreign capital and an extraordinary potential to step out on the world stage as a fully modern advanced economy.

Hence the investor must weigh out the choices: To reason that either Brazil will restructure its largely commodity export economy, or perhaps conclude that Mexico poses less risk, more diversified and a better managed emerging economy.

If so, there are several ways to invest in a single country ETF. However, Deutsche Asset and Wealth Management X-Tracker portfolio offers the Deutsche X-trackers MSCI Mexico Hedged Equity ETF (NYSEARCA:DBMX), which should help offset currency volatility as the US Dollar continues to gain strength. For investors with a long term horizon, currency translations usually balance out. However, in this case the fund's currency hedge has the advantage of Banco de Mexico's policy of maintaining US Dollar-Mexican Peso exchange parity through market intervention. Hence, the fund is virtually 'double hedged'.

Data from OEC

The fund's heaviest weightings are consumer staples and financials, industrials or materials follow and last are consumer discretionary and health care. The fund does not have an energy sector and included among consumer staples holdings are familiar large global or smaller domestic companies which distribute world class brand names.

Consumer Staples >1%

25.436189%

Ticker

Fund Weight

Market Cap

(in USD Billions)

P/E

Yield

5 Year Dividend Growth

Payout Ratio

Primary Business

Fomento Economico Mexica

FMX

9.2635533%

$1.852

159.41

1.44%

NA

NA

Holding Company of consumer product primary holding companies

Walmart de Mexico

BMV: WALMEX

6.8992149%

$45.616

29.07

19.43%

35.62%

108.21%

Walmart's Mexico subsidiary, including restaurants and banks

Grupo Bimbo SAB

OTCPK:GRBMF

2.6471832%

$12.665

50.29

0.00%

0.00%

0.00%

Retail bakery; multinational through subsidiaries

Kimberly-Clark de Mexico

OTCPK:KCDMF

2.1297271%

$6.759

30.78

3.62%

7.31%

111.86%

Kimberly-Clark's Mexico retail distribution subsidiary

Gruma SAB

OTC:GPAGF

1.6541762%

$6.073

23.73

0.96%

40.95%

33.16%

Holding company for subsidiary distributers of Mexican consumer food products

Arca Continental SAB de CV

OTC:EMBVF

1.4923413%

$9.643

23.18

1.53%

NA

40.11%

Coca-Cola brand name product distributer

Coca-Cola FEMSA SAB

KOF

1.3499933%

$5.089

25.88

2.48%

31.93%

62.22%

Coca-Cola Mexico distributer of brand names throughout South America

Averages

3.63%

$12.53

48.91

4.21%

23.61% x-NA

59.26% x-NA

Click to enlarge

Data from Reuters, Yahoo!

Consumer Staples Holdings of <1%

Market Cap (in USD billions)

Weight

Yield

GRUPO LALA SAB DE CV (OTC: OTC:GRPBF)

$5.859

0.9605481%

0.96%

CONTROLADORA COML MEXICO

$3.17

0.8843212%

0.93%

GRUPO COMERCIAL CHEDRAUI SA

$2.619

0.6153048%

0.53%

INDUSTRIAS BACHOCO (NYSE: IBA)

$2.400

0.5291989%

1.54%

GRUPO HERDEZ SAB (OTCPK:GUZBY)

$1.128

0.4830124%

2.00%

ORGANIZACION CULTIBA SAB CV (OTC:OCVLF)

$4.165

0.3067788%

0.00%

Totals

$19.34

3.78%

0.99% Avg

Click to enlarge

Data from Reuters, Yahoo!

The standout holdings are Walmart de Mexico, Kimberly-Clark de Mexico and Coca-Cola FEMSA. Notably, just over 10% of the fund and 35.5% of Consumer Staple holdings of the fund are global brands. One company needs special note. Arca Continental manufactures and distributes Coca-Cola (NYSE:KO) licensed beverages throughout Central and South America. The <1% holdings are Mexico based, mostly in food processing, beverages and distribution. However, they tally up to 3.78% of consumer staples hence do give a good representation of the domestic consumer staple industry.

Financials >1%

15.801294%

Ticker

Fund Weight

Market Cap

(in USD Billions)

P/E

Yield

5 Year Dividend Growth

Payout Ratio

Primary Business

Grupo Financiero Banorte

OTCQX:GBOOF

6.941232%

$14.9646

17.01

0.92%

40.16%

16.88%

Financial Holding Company: Banking, Trading, Mortgages, Pension, Business Services

Fibra Uno Administracion SA

3.104287%

$6.7035

24.08

4.93%

N/A

63.95%

Commercial and Industrial Real Estate Investments

Grupo Financiero Inbursa

OTC:GPFOF

2.550178%

$12.2307

14.97

1.34%

8.68%

19.99%

Financial Holding Company: Commercial, Investment Banking; Asset Management and Insurance

Grupo Financiero Santander

BSMX

1.917859%

$11.775

15.49

3.56%

NA

26.68%

Retail and Corporate: Brokerage, Financial and Asset Management Service

Gentera SAB de CV

OTC:CMPRF

1.287738%

$3.1687

18.53

2.29%

NA

84.14%

Formerly Compartamos SAB de CV. Credit Services, Insurance, Micro Financing, Administration Services

Averages

3.16%

$9.77

18.016

2.61%

24.42% x-NA

42.33%

Click to enlarge

Data from Reuters, Yahoo!

Financial Holdings of <1%

Market Cap (in USD billions)

Weight

Yield

BANREGIO GRUPO FINANCIERO SA (BMV: GFREFIOO)

$1.670

0.7816528%

0.92%

MACQUARIE MEXICO REAL ESTATE

$0.471

0.7194506%

6.58%

Terrafina SA de CV (BMV: Terra13.MX)

$0.996

0.6775131%

6.64%

CORP INMOBILIARIA VESTA SAB (OTC:IMQCF)

$0.947

0.5828582%

1.84%

PROLOGIS PROPERTY MEXICO SA

$0.985

0.4150243%

5.13%

BOLSA MEXICANA DE VALORES SA (OTC: OTC:BOMXF)

$0.792

0.4012039%

3.75%

GRUPO FINANCIERO INTERACCIONES SA de CV (BMX: GFINTERO)

$1.640

0.3825613%

1.75%

CREDITO REAL SAB DE CV (BMV: CREAL)

$0.933

0.3696917%

0.53%

CONCENTRADORA FIBRA HOTELERA

$0.449

0.355519%

5.34%

FIBRA SHOP PORTAFOLIOS INMOB (BMV: FSHOP13)

$0.522

0.3488025%

5.58%

QUALITAS CONTROLADORA SAB CV

$0.594

0.2974682%

0.00%

UNIFIN FINANCIERA SAPI DE CV (OTC:UFFRF)

$1.091

0.1160817%

0.00%

GRUPO GICSA SA DE CV (BMV: GICSAB)

$1.453

0.1138563%

0.00%

Totals

$12.54

5.561684%

2.93% Avg

Click to enlarge

Data from Reuters

Grupo Financiero Banorte is a premier Mexican financial services company as well as being one of the oldest and largest retirement fund management financial service in the country. The important thing to note, again, is the collection of <1%. Of the 13 there are 8 REITS or real estate holding companies, 2 credit and leasing services companies and 3 banks. A good rule-of-thumb for ETF investors is to have an idea of the general composition of the smaller holdings and consider it as one company. For example, in this case the collection of <1% holdings tallies up to over 5.5% and heavily weighted in real estate. As a single company, it would be the second largest financial holding and a virtual REIT.

Telecom Services >1%

12.722808%

Ticker

Fund Weight

Market Cap

(in USD Billions)

P/E

Yield

5 Year Dividend Growth

Payout Ratio

Primary Business

AMERICA MOVIL SAB DE CV

AMX

12.722808%

$47.847

36.49

4.12%

-13.35%

151.73%

International, full telecom services provider

Click to enlarge

Data from Reuters

Telecom Services Holdings of <1%

Market Cap (in USD billions)

Weight

Yield

Telesites S.A. de CV (BMV: SITESL)

$0.748

0.596318%

0.00%

AXTEL SAB DE CV

$1.102

0.332014%

0.00%

Totals

$1.85

0.93%

0.00%

Click to enlarge

The sector is dominated by America Movil SAB de CV at 12.723%. It's a large holding amounting to 93% of the entire sector's allocation. America Movil has earned its position having the 4th largest subscriber base, globally and one of the world's largest corporations in general. This is one of several excellent examples demonstrating the potential of the Mexican economy. America Movil was initially a venture startup project of billionaire investor Carlos Slim.

Industrial Holdings of >1% 10.226926%

Ticker

Fund Weight

Market Cap

(in USD Billions)

P/E

Yield

5 Year Dividend Growth

Payout Ratio

Primary Business

Alfa SAB

OTCPK:ALFFF

3.346612%

$10.305

22.64 appx

1.20%

-22.99%

NA

Petrochemicals, automotive, telecom, and also food processing

Grupo Aeroport Del Sureste

NYSE: ASR

1.871779%

$4.311

27.55

2.06

NA

56.75%

Airport Management Holding company

Promotora Y Operadora De Infraestructura

OTC:PYOIF

1.796121%

$5.267

22.27

0.00%

0.00%

0.00%

Infrastructure Construction, Engineering and Management

Grupo Aeroport Del Pacific

PAC

1.725105%

$5.123

32.08

2.68%

5.79%

42.16%

Airport Management Holding company

Grupo Carso SAB De CV

OTC:GPOVF

1.487309%

$9.529

29.53

1.16%

4.44%

45.77%

Infrastructure, Industrial Construction; also Consumer Retail operations

Averages

2.05%

$6.91

26.814

1.42%

-3.19% x-NA

36.17% x-NA

Click to enlarge

Data from Reuters, Yahoo! and others

Industrial Holdings of <1%

Market Cap (in USD billions)

Weight

Yield

GRUPO AEROPORTUARIO DEL CENTRO (NASDAQ:OMAB)

$1.559

0.6787549%

6.23%

GRUPO AEROMEXICO SAB DE CV (OTCPK:GRPAF)

$1.602

0.6152811%

0.00%

OHL MEXICO SAB DE CV (OTC:OLMXF)

$1.854

0.5855855%

0.00%

CONTROLADORA VUELA CIA DE

$3.129

0.564517%

0.93%

GRUPO ROTOPLAS SAB DE CV NPV (BMV: AGUA)

$0.808

0.3117186%

0.00%

EMPRESAS ICA SAB (NYSE: ICA)

$0.129

0.1403059%

0.00%

ELEMENTIA SAB DE CV (BMV: ELEMENT)

$1.089

0.1254433%

0.00%

Totals

$10.17

3.02%

1.02% Avg

Click to enlarge

Data from Reuters, Yahoo! and others

The larger industrial holdings are pretty much standard including airport management, chemical and food processing and construction. The collection of smaller holdings, which total 3.02% are weighted towards air transportation, particularly in airport management and infrastructure construction.

Materials Holdings of >1% 9.488864%

Ticker

Fund Weight

Market Cap

(in USD Billions)

P/E

Yield

5 Year Dividend Growth

Payout Ratio

Primary Business

Grupo Mexico SAB de CV

OTCPK:GMBXF

4.217608%

$16.951

12.15

2.55%

30.97%

49.32%

Metallurgic Sector Holding Company

Cemex SAB

CX

3.798852%

$7.338

NA

0.00%

0.00%

0.00%

International construction materials such as cement, aggregates, concrete

Mexichem SAB de CV

OTCPK:MXCHF

1.472404%

$4.797

52.83

0.48%

0.00%

54.09%

Specializing in chemical products for industrial, construction and agriculture

Averages

3.16%

$9.70

32.49

1.01%

10.23%

34.47%

Click to enlarge

Data from Reuters, Yahoo! and others

Material Holdings of <1%

Market Cap (in USD billions)

Weight

Yield

INDUSTRIAS PENOLES SAB DE CV (OTC: OTCPK:IPOAF)

$4.151

0.918019%

0.84%

INDUSTRIAS CH S SAB (BMV: ICHB)

$1.384

0.380631%

0.00%

MINERA FRISCO SAB DE CV (OTC: OTCPK:MFRVF)

$1.250

0.316659%

0.00%

GRUPO SIMEC SA (NYSEMKT:SIM)

$1.079

0.251299%

0.00%

Totals

$7.86

1.866608%

0.21% Avg

Click to enlarge

Data from Reuters, Yahoo! and others

If commodities affect the fund at all, it would be in the materials sector, dominated by Grupo Mexico one of the world's largest producers of copper. Second is Cemex a global distributor of cement, concrete and aggregate. Third is Mexichem a leading producer of PVC piping and other construction related materials, although part of the business produces materials used in consumer staple products. The smaller holdings, totaling 1.867% are split with two mining and two steel producing companies. So as it is with almost all single country focused funds, this sector will weigh on the fund for as long as global commodity prices remain low.

Consumer Discretionary >1% 9.653648%

Ticker

Fund Weight

Market Cap

(in USD Billions)

P/E

Yield

5 Year Dividend Growth

Payout Ratio

Primary Business

Grupo Televisa SAB

NYSE: TV

7.141043%

$17.284

23.47

0.33%

0.00%

9.16%

International Americas-Spanish Language content provider

El Puerto de Liverpool

OTC:ELPQF

1.425141%

$17.825

32.51

0.17%

0.00%

7.67%

Retail Department Stores and Duty-Free Shops, Retail RE management; and branded Visa Card

Alsea SAB de CV

1.087464%

$2.870

60.63

0.85%

0.00%

51.37%

Food Retail Franchise Group Holdings

Averages

3.22%

$12.66

38.87

0.45%

0.00%

22.73%

Click to enlarge

Data from Reuters, Yahoo! and others

Although it may be considered 'discretionary', Grupo Televisa is a premier global media and entertainment company, providing popular South American Spanish language content via satellite, cable, wireless and print to 83 countries, not counting the US. As with America Movil, Groupo Televisa demonstrates the untapped potential of the Mexican Economy: technically state-of-the-art and global in scope with cultural demographic of over 330 million people in 19 countries, not counting Mexico's Northern NAFTA partners. The <1% holdings of the consumer discretionary allocation include hotels, specialty real estate and department stores all adding up to just over 1%.

Health Care Holdings of <1%

Market Cap (in USD billions)

Weight

Yield

GENOMMA LAB INTERNACIONAL (GMNLF)

$0.797

0.466606%

0.00%

Click to enlarge

Data from Reuters, Yahoo! and others

There's only one Health Care holding, Genomma Lab, a pharmaceutical specializing in generic drugs as well as personal care products. It should be noted that Mexico does not have a single payer health care system. Mexico's health care is provided in two ways: individual payer and government reimbursement to providers for those without insurance. It should also be noted that health care service in Mexico is a constitutional right for all citizens. The system is fragmented; hence the potential exists for consolidation.

Click to enlarge

As for the fund itself, it is passively managed and the investor needs to be aware that it is very lightly traded averaging a few hundred shares per trading session on the NYSE. It first listed just about two years ago, January 23 2014 and currently has $4.118 million in assets. Its total management fee is reasonably fair at 0.50% and the fund is currently trading at a premium of 0.04% to NAV. The tracking index is from the MSCI portfolio of Hedged and Capped single country indexes. Since the fund is relatively new, there's little data to go by, however the index may serve as a gauge as to how well a tracking fund would have performed.

MSCI Mexico IMI USD Hedged Index

1 Month

3 Months

1 Year

YTD

3 Year

5 Year

10 Year

Since Index Inception 12/31/2003

Index Percent Return

1.03%

5.08%

-3.48%

-3.48%

3.16%

13.74%

14.12%

14.14%

Click to enlarge

Data from Reuters, Yahoo! and others

The fund hedges by entering:

... into forward currency contracts designed to offset the Fund's exposure to the Mexican peso. The Fund hedges the Mexican peso to the U.S. dollar by selling Mexican peso currency forwards at the one-month forward rate..." Lastly the 25/50 capping is an IRS rule requiring that "...at the end of each quarter of its tax year no more than 25% of the value of the RIC's assets may be invested in a single issuer and the sum of the weights of all issuers representing more than 5% of the fund should not exceed 50% of the fund's total assets...

It is unfortunate that bad news makes headlines. No doubt, Mexico has had its share particularly with respect to the illegal drug cartels. These cartels have literally engaged in wars against each other resulting in civilian casualty numbers among the highest among recent global conflict zones. However, what is often overlooked is a sophisticated modern culture, a long history, an aggressive international growth plan, strong trade relationships, a responsible and innovative central bank and a progressive government. If the investor considers the many billions of dollars of foreign capital, successfully invested by global corporations then it's worth considering as a portfolio holding.

Again, investors with a long term horizon who wish to include a South or Central American focused country fund in their portfolio, should compare the 'future potential' of the Mexican economy versus the only other continental leader, Brazil. It may be that Brazil had become too heavily dependent on commodity exports and inflation seems to have gotten a bit out of hand. Will Brazil recover? No doubt, but a great deal of restructuring may lie ahead. One the other hand, Mexico seems well on the path leading a fully emerged advanced economy on the world stage.

Mike Scrive

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.