Going Back to Rio

08/18/2008 12:00 am EST

Focus: ETFS

Paul Justice

Associate Director of North American ETF Research, Morningstar, Inc.

Paul Justice, ETF strategist, Morningstar ETFInvestor, doesn’t think the carnival is over in Brazil just yet.

The Brazilian equity market has been on a remarkable six-year run. Even though recommending iShares Brazil MSCI Index (NYSEArca: EWZ) appears to stink of performance-chasing, we think that investors with limited exposure to commodities and emerging economies should take a careful look at this country-specific ETF.

It tracks the MSCI Brazil Index, which covers more than 60 firms that trade primarily on the Bolsa de Valores de Sao Paulo. The fund's holdings, weighted by market cap, represent about 85% of the Brazilian stock market. Large-cap stocks account for nearly 90% and the top 10 holdings comprise more than 70% of assets. The Brazilian economy is heavily tied to commodities; thus, the fund invests more than one third of assets in mining and steel producers, with another one fourth devoted to energy stocks. The fund does not hedge its investments back to the US dollar, which increases both its volatility and its diversification benefits.

Owning this fund either in isolation or as a large portfolio overweight, at perhaps more than 5% of your equity exposure, would be an exercise in speculation. However, as a satellite specialty holding, this ETF’s unhedged currency component and low correlation to the US market make it a good diversification tool.

The enduring five-year commodities boom has brought a great influx of wealth into Brazil, making it now the world’s largest emerging economy. Earlier this year, Standard & Poor’s raised its debt rating to investment grade, making it one of only 14 sovereign nations to earn such status. Blessed with an abundance of natural resources, Brazil is a major commodity exporter, while remaining self-sufficient in terms of electric generation, fuel production, water availability, and agricultural output.

Perhaps the most impressive aspect of Brazil’s remarkable turnaround has been the fiscal and monetary discipline exhibited by the current administration. Inflation remains high, but Brazil’s central bank has maintained a forward-looking policy to ensure that the pains of yesteryear are muted.

Brazil is attracting the wealth of other nations by exporting its natural endowment to foreigners at higher prices. This wealth transfer benefits both the commodity-based companies and the secondary levels of the local economy, such as utilities, consumer-related goods, and so on. Therefore, holding a large diversified basket of Brazilian equities, such as this fund, is really an investment on regional prosperity beyond its commodity underpinnings.

This fund levies a 0.69% expense ratio. As the only Brazil-focused equity fund around, it has no price competition. That said, you can buy a more broadly diversified Latin America fund for less.

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