FLLA - FLLA: Investing In Latin America Sort Of

2023-04-03 09:00:00 ET

Summary

• The Franklin FTSE Latin America ETF is an index-based ETF that invests in the Latin America and Caribbean region of the Western Hemisphere (sort of).
• Investment selection is based on the FTSE Latin America RIC Capped Index. Despite the name, 90% of the assets are in two countries: Brazil and Mexico.
• This article covers the index and ETF compositions. Considering the weight of Brazil and Mexico, country insights are provided.
• Unless the investor wants high Brazil/Mexico exposure, I would look to use individual country funds for investing in these Emerging Market countries.

(This article was co-produced with Hoya Capital Real Estate )

Introduction

Emerging Markets breakdown into four main regions: Asia, Africa, Eastern Europe and Latin/South America, with Asia, especially China, getting the bulk of the attention and investment dollars. Despite its name, the Franklin FTSE Latin America ETF (FLLA) invests is a very limited segment of its target region. Besides Africa, Latin/South America supposedly offers the most potential for good investment results for Emerging Market investors. Overall, since 1995 EM stocks have lagged US equities but have outperformed the International Developed Market equities.

Unless the investor wants high Brazil/Mexico exposure, I would look to using individual country funds for investing in these Emerging Market countries. I list some possible single-country ETFs to examine in more depth.

Understanding EM investment opportunities

Economic and country analysis is not in my top skill set, so here is what some major players think.

Franklin Templeton's view

Latin America is endowed with abundant natural resources, a growing population, and proximity to the vast American consumer market. We have identified three themes that we believe are likely to drive continued performance in the years ahead:

• Supplying the renewable energy revolution. The region is well placed to take advantage of the opportunities created by the renewable energy revolution with 54% of global lithium reserves1 concentrated there. Latin America is also the leading producer of copper, and iron ore.
• Nearshoring and increased US trading opportunities. Mexico is a beneficiary of the China+1 strategy, where manufacturers add additional production capacity outside China. It can also benefit from the United States-Mexico-Canada (USMCA) agreement and the US Inflation reduction Act (IRA).
• Consumption. Surging demand for commodities globally has boosted exports and created a trickle-down effect in the region, expanding the middle class while driving financial deepening and increasing demand for consumer goods.

Source: franklintempleton.co.uk

Morgan Stanley's view

• Inflation in Latin America peaked in June 2022 , giving policymakers more runway to potentially begin slowing monetary tightening-a likely boon for the region's stocks.
• Latin American equities are trading cheaply , relative to both their own history and global peers, and could outperform emerging-market stocks broadly.
• Brazil may benefit from expansion of trade with China . Mexico could see a surge in exports to the U.S. as businesses move supply chains closer to home.
• They are poised to outperform EM stocks broadly. In the past, then Latin American equities have traded more cheaply than the MSCI EM Index at bear-market troughs-as they recently did, by the widest margin in more than 20 years-the region's stocks have gone on to beat the broader EM index by a median 20% to the next cycle peak.
• We believe the strong U.S. dollar may lose momentum. As the Federal Reserve's rate-hiking cycle matures and relative economic growth outside the U.S. improves, allowing EM economies to benefit.

Source: morganstanley.com

Franklin FTSE Latin America ETF review

Seeking Alpha describes this ETF as:

The fund invests in public equity markets of Latin America and Caribbean region. It invests in stocks of companies operating across diversified sectors. It invests in growth and value stocks of companies across diversified market capitalization. The fund seeks to track the performance of the FTSE Latin America RIC Capped Index . THE ETF started in 2018.

FLLA has $64m in AUM and the managers are collecting 19bps in fees. If the recent payouts hold, the yield is about 10%.

Index review

FTSE Russell describe their index as:

The FTSE Global RIC Capped Indexes are market-capitalization weighted indexes designed to limit concentration in any single security to help users meet the Regulated Investment Company ((RIC)) concentration requirements for US registered funds. The FTSE Global RIC Capped Indexes are a subset of the FTSE Global Equity Index Series (GEIS), which covers 99% of the world's investable market capitalization. The FTSE Latin America RIC Capped Index represents the performance of Latin American large and mid capitalization stocks. Securities are weighted based on their free float-adjusted market capitalization and reviewed semi-annually. To limit over concentration in any single security, constituents are capped quarterly so that no more than 20% of the index's weight may be allocated to a single constituent and the sum of the weights of all constituents representing more than 4.5% of the index should not exceed 48% of the total index weight.

Source: research.ftserussell.com index

The index shows data back to 2013, versus FLLA results only back to 2018.

Like African countries, the four comprising this index have not always delivered to investors, especially over long periods.

Country review

The Index only has four countries, with two dominating the portfolio. With such a limited diversification, investors better like the countries included, even considering that most EM stocks are heavily dependent on exports.

Using the stats.oecd.org database, I thought these statistics were important to this review.

Growth and Inflation are 2024 projections. Trust refers to what each country's population has in their own government. Note the USA low rating! For the most part, the country data is better than the overall OECD data.

In reverse order of importance to FLLA:

Columbia: Located on the northern coast of South America, it is possible this is the most stable country of the four, in my view. Colombia has substantial oil reserves and is a major producer of gold, silver, emeralds, platinum and coal, but controlling the cocaine trafficking is still an issue, as is the large percentage of the population living in poverty.

Chile: The current leftist government has spent the past two years writing a new progressive constitution, but the document was defeated by voters last September, leaving the country's future policies undefined. As with the next two countries reviewed, the country seems to moving to the left in its attitude toward private enterprise. As noted below, this has had a negative effect on the foreign investment that had greatly improved the country's poverty rate over the past decades.

Mexico: With its size, population, and location just south of its biggest trading partner, Mexico should be poised for growth, especially with the USA's desire to bring the supply chain closer to home. Working against those positives are drug cartels, dealing with illegal immigrants trying to cross the USA border, and what many see as a weak democracy. The current ruling party and their president, Andrés Manuel López Obrador, also known by his initials AMLO, seem to be reverting to economic policies that will discourage the foreign investment Mexico needs to capitalize on their location and natural resources.

Brazil: Except for its location and the USA border issues, Brazil has similar issues as Mexico. Luiz Inácio Lula da Silva, known as Lula, also has his own issues. As with Mexico's oil industry, recent events are bringing into question how welcome foreign corporations are in developing the new offshore oil fields. That resource is critical to balancing the national budget.

Holdings review

With almost 50% of the portfolio in Cyclical sector stocks, FLLA should not perform well if the inflation-fighting recession becomes a reality. Only 26% is in Defensive sector stocks. Compared to its index and the Latin America category, FLLA matches up well.

The current country allocations are:

The above is why investors need to look inside any fund, not invest based on the fund's name; most countries in Latin and South America are missing from FLLA's holdings.

Top 20 holdings

FLLA holds 147 stocks (plus one BRZ future), with the Top 20 comprising 58% of the portfolio. The lower half (by weight) come to 13% of the portfolio's weight. The currency code will tell readers the country. This also shows where the currency risk is if the USD is strong against them.

Distribution review

As you can see, payments are semi-annual and starting in 2022, exceed what investors received prior to that. In picture form, the yield looks like this:

Portfolio strategy

I believe the fact that most of the illegal immigrants entering the US via the US-Mexico border who are asking for asylum are from these countries likely tells us what their countries are like compared to what they think the USA can provide. But in that tragic situation comes both investing risk and possibly rewards.

One approach is picking ETFs that are single-country focused for Mexico and South America. These are some of those I found. I could not find any other Central America ETFs.

While at 5-years, the returns lag, many of these ETFs in the last three years outperformed the Vanguard Total Stock Market ETF ( VTI ), representing the total US equity market. The list includes ETFs that invest in only one country, all of which differ. This allows the investor to set their allocation to this region, versus owning a regional ETF like FLLA.

For further details see: