FLBR - FLBR: Low-Cost Exposure To Brazil Stocks

2023-09-28 03:39:41 ET

Summary

• The Franklin FTSE Brazil ETF invests across the most important Brazilian companies.
• We highlight key advantages of FLBR compared to the larger iShares MSCI Brazil ETF including a lower expense ratio and historical outperformance.
• Improving macro data out of Brazil supports a positive outlook for Brazil stocks.

The Franklin FTSE Brazil ETF ( FLBR ) offers targeted exposure to Brazilian stocks as a country-specific exchange-traded fund. The attraction here is some encouraging macro data out of Brazil between positive economic growth and easing inflationary pressures, in contrast to more headwinds facing other emerging markets ((EM)).

Indeed, FLBR has outperformed the iShares MSCI Emerging Markets ETF ( EEM ) this year while we can also highlight several advantages of the fund compared to the larger and the more widely traded alternative iShares MSCI Brazil ETF ( EWZ ).

In our view, FLBR is a good option for investors to invest in Brazil stocks that are benefiting from several factors. This is a volatile market segment, but we expect the fund to deliver positive long-term returns and work in the context of a diversified portfolio.

What is the FLBR ETF?

FLBR passively tracks the "FTSE Brazil Capped Index". This is a free-float adjusted capitalization-weighted bench benchmark that tracks the largest companies in the Brazilian equity market. Holdings are rebalanced semi-annually.

The term "capped" in the index name refers to the criteria that a single stock is limited to no more than 20% of the total allocation. Separately, the sum of all investments representing more than 4.5% of the index should not exceed 48% of the total index weight.

The other important feature of FLBR is that the majority of stocks are classified as large with a market value above $10 billion. These are typically major corporations recognized for their sector leadership and otherwise well-established governance.

FLBR vs. EWZ

We mentioned the EWZ ETF as a benchmark for Brazil stocks. In this case, the data shows both FLBR and EWZ are highly correlated with similar returns over the last several years, despite technically tracking different indexes. This is because there is a significant overlap among top holdings.

Vale SA ( VALE ), Petrobras SA ( PBR ) ( PBR.A ), and Itau Unibanco Holding SA ( ITUB ) are the three largest positions in both FLBR and EWZ. FLBR stands out as less "top-heavy" with the top-10 holdings representing 52% of the fund compared to 57% in EWZ.

The Franklin FTSE Brazil ETF also has a larger number of holdings at 87 compared to 54 in the iShares MSCI Brazil. At the margin, FLBR offers a bit more exposure to smaller companies down the line which we believe is a positive in terms of diversification.

It's also notable that FLBR has an expense ratio of just 0.19% compared to 0.58% by EWZ. In our view, FLBR is simply a better option as a long-term portfolio holding for exposure to Brazil stocks given its low-cost profile.

Currently, the dividend yield for FLBR is listed at 12% while EWZ is 9%. These rates captured what were exceptionally large distributions by names like VALE and PBR over the past year. The expectation is that they normalize a bit lower, but still represent a high-yield opportunity.

The spread between EWZ and FLBR's payout is mostly due to each of their distribution's timing. The next payout from FLBR is expected in December, following a pattern of semi-annual distributions which has been in place since 2017.

Brazil Macro Data

The good news is that economic data from Brazil has been improving. The story in Latin America's largest economy this year has been the ongoing disinflationary process with the ((IPCA)) consumer price index reaching 4.6% in August, down significantly from the cycle peak of 10.1% back in 2021 and even 5.8% to the end of 2022.

That trend has given the Central Bank confidence to cut the policy interest rate, through two separate 50bps decreases down to the current level of 12.75%. The Economics team at " Itau Research " is forecasting further cuts this year taking the end-of-period rate to 11.50%.

The group cites the easing monetary policy as contributing to a rebound of the credit cycle as positive for the broader economy. A firm labor market highlights the overall stability.

Itau Research has revised its full-year GDP growth estimate to 2.9% for 2023, up from a prior forecast of 2.5%. For 2024, the expectation is that some of that momentum is maintained at a 1.8% rate despite the more challenging external macro environment.

What's Next For the FLBR ETF?

In our view, the positive economic backdrop is positive for the Brazilian stock market, particularly for companies with exposure to consumer spending and domestic trends.

International trends are important as they relate to export markets through companies like VALE and PBR, but the understanding is that Brazil is diversified enough with a well-developed services side that it remains relatively isolated from the geopolitical situations in developed markets.

We're talking about headline events like a potential U.S. government shutdown or the imbroglio of the Russia-Ukraine war in Europe. There is still exposure to key trade partners like China, but there is a sense that at this stage in the cycle, Brazil has decoupled more positively as it moves to cut interest rates while other parts of the world are tightening.

A risk to consider when thinking about investing in international stocks is the FX volatility with the potential of local currency depreciation. On this point, we can go back to the macro data from the table above that shows a narrowing current account deficit with a near-record trade surplus expected to reach $80 billion this year. These metrics along with a relatively stable net debt to GDP level could be supportive for the Brazilian Real against U.S. Dollar strength.

Final Thoughts

FLBR is a high-quality fund that performs exactly as intended for exposure to a large basket of the most important Brazilian stocks. We believe the fund deserves consideration from investors looking at this segment of the market.

Overall, we see FLBR trading higher over the next year with Brazil stocks well-positioned to outperform among emerging markets. From the ETF price chart, we're eyeing an uptrend in place since a low in March. The current level around $18.00 in the fund appears like an attractive entry point in our opinion.

In terms of risks, a deeper deterioration to the global macro outlook and a new round of financial market volatility would likely sour sentiment towards emerging markets and Brazil. We mentioned FX risk as a key consideration. Political developments are also important monitoring points as well as corporate updates from the major fund holdings.

For further details see: