PBR - iShares Latin America 40 ETF: Right Region Not The Best Vehicle

Summary

• This article will cover the iShares Latin America 40 ETF. This exchange-traded fund is an ok, but not the best, vehicle to access Latin American equities.
• The key appeal of Latin American equities is the fact that these are very cheap on a historical basis, although the political and economic risks are not terrible.
• In the current environment, emerging market outperformers will not necessarily be the countries with the clearest investment narrative.
• Instead, markets in Latin America might outperform.

iShares Latin America 40 ETF

This article will cover the iShares Latin America 40 ETF (ILF) and cover how this exchange-traded fund ("ETF") is not the best vehicle to access Latin American equities. I still have a hold recommendation on ILF because I am bullish on Latin American equities, and think this ETF will still perform well.

Why Latin America?

Select Latin American economies have benefited from higher export revenue due to the price of commodities rising. Around half of the exports from Brazil, Argentina and Colombia are classified as primary products , while countries like Mexico are able to export higher-end manufacturing products. This is one reason why many investors prefer Mexico and are willing to pay a premium to invest in this market.

While a rise in the price of copper, oil, or agriculture products is good for many of these economies in the short run, the lack of value-added exports has made the region's growth lag behind regions like Asia.

Key risks in the region include higher inflation, slower economic growth, and political shifts seen in countries like Chile, Colombia, Peru, Brazil, and Bolivia. Some political transitions have had a negative impact on economic sentiment due to anti-oil or mining ( key parts of the economy) sentiment. This risk may also have a spillover effect on the equity markets in these countries.

Source: Trading Economics

Every country in this region is struggling with higher inflation, and most Central banks, with the exception of Brazil, have limited room to cut rates based on current inflation numbers.

Some currencies , such as the Mexico Peso and Brazilian real, rose against the USD during the first ten months of 2022. Sovereign debt, which is likely one of the biggest issues facing emerging markets, is still within manageable levels for some of these countries, particularly Chile. I have observed more troubling trends in other countries in South Asia and Africa, and am only really worried about Brazil and Argentina.

Acceptable Risks, High Return Potential: Regional Valuation is Compelling

The key appeal of Latin American ("Latam") equities is the fact that these are very cheap on a historical basis, although the political and economic risks are not terrible. Most of these countries, with the exception of Mexico, are trading at a substantial discount to MSCI Emerging Markets.

Source: MSCI latest data

Meanwhile, markets in emerging Asia like Indonesia and Malaysia are trading at 15-16x earnings, an approximate 40% premium to MSCI emerging markets. This comparison is interesting on multiple levels:

• Latam equities are trading at distressed levels, even though economic conditions are not terrible. This provides a higher chance of one outperforming the MSCI Emerging Markets index, as much of the 2023 pain is already priced in.

• Investors are willing to pay a premium for higher growth in Asian countries (5+%) and perhaps higher levels of political stability. However, these markets still seem priced for the best, and vulnerable to a correction.

• Most Asian countries are net importers of oil, gas, and metals, while Latin American economies are strong commodity exporters. If you are bullish commodities, and willing to take on political risks, buying Latam at a discount is an obvious choice.

In the current environment, emerging market outperformers will not necessarily be the countries with the clearest investment narrative, but rather countries with acceptable risks that are priced as if they have high risks. Latam equities certainly fit the bill for this description.

ETF Peers

I think now is the right time to begin investing in Latin America, and it is only a matter of finding the right vehicle. Below are some of the main peer ETFs, which include Latin America and Brazil ETFs ( most of this fund’s assets are in Brazil). If you are aiming for a Latin America-focused ETF, then this ETF is probably the best one for you to consider. However, there are ways to improve your exposure to Latin America by building your own Latin American portfolio, especially if you are bullish on Chile or Colombia.

Fees : The iShares Latin America 40 ETF is competitive based on fees. This ETF only charges a 0.47% fee is ok, which is competitive relative to other ETFs, which charge between 0.19-0.80%. However, most country-specific ETFs have much lower fees.

AUM : The iShares Latin America 40 ETF assets under management ("AUM") is over $1 billion, a far cry from other Latin American ETFs listed. Smaller ETFs can be liquidated at times, especially when economic conditions deteriorate (i.e., the previous Global X Central Asia ETF ). While liquidation of an ETF is not a cause for alarm ( the prices won't plunge weeks or months before), it can be frustrating to have to spend time searching for new vehicles and rebalancing if this happens.

Geographical Exposure : Most of the Latin American ETFs are extremely overweight in Brazil (over 50% of assets). Furthermore, if you invest in a general emerging market ETF, it may also have 10% or less of its assets invested in Brazil.

Franklin Templeton ETF Trust- Franklin FTSE Latin American ETF

Most Latin American ETFs primarily invest in Brazil and Mexico and provide less exposure to smaller, but key, markets like Chile and Colombia.

ILF has a similar breakdown, with the main difference being a lower weighting in Chile and strong exposure to Peru. If I had to choose an ETF, I would choose the ETF with stronger exposure to Chile.

Custom Latam Exposure

Investing in a basket of country ETFs, or even ADRs could allow you to diversify your exposure to the region. Investment preferences may vary, but I find it ideal to invest more in Chile and Colombia and less in Mexico.

I am personally avoiding Mexico and Peru for the time being and investing in Brazil, Chile, and Colombia. Colombia and Chile, in particular, are interesting because of the strong commodity exposure and historical underperformance during the past five years. I am also setting aside plenty of cash, as broader emerging market turmoil or political risks in specific countries could result in stronger sell-offs.

Notes on Top Holdings

Some of the ETF’s top holdings, such as Petrobras (PBR) and Banco Bradesco (BBD), are also very interesting and can be purchased for $0 trading fees on some brokerages. These products can be great if you want to make a more concentrated bet on Brazil's banking and energy sectors. These stocks have had stronger drawdowns during the past decade.

The ILF ETF is still an acceptable vehicle, and I don't foresee any issues in terms of tracking errors/drastic underperformance. However, it is worth the time to venture out if you are bullish emerging markets, and prefer being overweight Latin America.

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