MXF - Mexico Fund: Benefiting From Frosty U.S.-China Relations
Summary
- The MXF fund provides exposure to Mexican investments.
- The fund has a long operating history and has outperformed the MSCI Mexico Index on a 3/5/10 yr basis.
- As Mexico benefits from a flow of capital out of China, I expect MXF will continue to outperform.
The Mexico Fund ( MXF ) is a closed-end fund focused on Mexican investments. The MXF fund has outperformed the MSCI Mexico Index on a 3, 5, and 10Yr basis and pays a 4.8% forward yield.
I expect MXF will continue to outperform as Mexico benefits from a shift in investment flows out of China with American companies look to shorten and retool their supply chains.
Fund Overview
The Mexico Fund ( MXF ) is a closed-end fund ("CEF") that primarily invests in Mexican companies listed on the Mexican Stock Exchange. The fund's investment objective is long-term capital appreciation, although the fund pays a steady distribution to shareholders as well.
The MXF fund has a long operating history with $303 million in assets as of January 31, 2023. The MXF fund charges a 1.36% expense ratio.
Portfolio Holdings
MXF is a fairly concentrated fund with the top 10 holdings accounting for 67% of the fund's assets. The fund has 26 positions in total.
Overall, the fund's holdings are skewed towards Consumer staples (30.8%), Materials (22.7%), Communications (15.7%), and Industrials (12.5%) (Figure 3).
Returns
The MXF fund has done well in the past few years, with 1 and 3Yr average annual returns of 21.5% and 12.0% respectively to January 31, 2023. However, long-term performance have been more modest, with 5/10/15Yr average annual returns of 5.0%/1.0%/2.9% respectively.
MXF's return struggles appear to be primarily caused by the asset class, Mexican equities, rather than stock selection. Compared to the MSCI Mexico Index, the MXF fund has outperformed the index on a 1/3/5/10Yr time frame (Figure 5).
Figure 5 - MXF has outperformed MSCI Mexico Index over the long-run (MXF January report)
Distribution & Yield
MXF pays a competitive quarterly distribution, currently set at $0.20 / quarter or 4.8% annualized yield (Figure 6). On the latest NAV of $20.33, the MXF fund is yielding 3.9%.
MXF's distribution is partly funded by net investment income ("NII"), realized gains, and return of capital ("ROC"). Although the MXF fund have utilized ROC to fund its distribution, I do not believe it is an amortizing 'return of principal' fund that cannot earn its distributions and must instead fund it by liquidating the fund's NAV.
On a 5 year basis, the fund has earned average annual total returns of 5.0%, vs. the current forward yield of 3.9% of NAV.
Mexico Benefiting From Frosty U.S.-China Relations
In recent years, we have seen the trade relationship between the U.S. and China deteriorate significantly, first with former President Trump's 'trade war' which saw the two countries impose tens of billions in tariffs on each other. More recently, President Biden has enacted a semiconductor 'chip war' , limiting the export of microchip technologies to China that might be repurposed for military applications.
The result of frosty relations between U.S. and China is a boom in foreign investments in alternative locales like India and Mexico . In fact, Mexico, as a core member of USMCA ("United States–Mexico–Canada Agreement"), is one of the chief beneficiaries of American companies' desire to reduce their dependence on Chinese manufacturers.
According to the U.S. Census bureau , Mexican exports to the U.S. increased 18% YoY in 2022 to $455 billion, surpassing Canada to be the #2 exporter to the U.S. after China .
Figure 7 - Trade between U.S. and Mexico continue to grow (U.S. Census Bureau)
MXF Trading At A Steep Discount
Although the MXF fund has performed well in the past few years, it continues to trade at a steep discount to NAV, with the discount reaching 18% recently (Figure 8). However, if we look back through history, the MXF fund actually traded at a premium to NAV in ~2013, when investing in Mexico was last in vogue.
Figure 8 - MXF trades at a steep discount to NAV (cefconnect.com)
Technicals Suggest Mexico Outperformance Is Only Beginning
After a decade of relative underperformance, as represented by the ratio of the MXF fund versus the SPDR S&P 500 Trust ETF ( SPY ), Mexico's favourable economic potential finally manifested itself in the past few years with the MXF/SPY ratio breaking an eight year downtrend in late 2021, followed by higher highs and higher lows in 2022 (Figure 9).
Figure 9 - MXF/SPY beginning to outperform (Author created with price chart from stockcharts.com)
Looking forward, I believe the outlook remains bright for the MXF fund, as Mexico continues to enjoy a shift of investment flows out of China.
Importantly, Mexico is rich in minerals such as copper and lithium. If the coming decade is characterized by a shift toward 'energy transition' investments, Mexico's economy will likely stand to benefit, similar to the early 2000s.
Risks To MXF
The biggest risk to the MXF fund is its high concentration in a handful of companies. As shown in figure 2 above, the MXF fund has 67% of its assets in 10 companies, with the largest position, American Movil, accounting for 13.1%. If any of MXF's top holdings were to suffer a negative catalyst, for example, a poor earnings report, the MXF fund could be disproportionately affected.
Conclusion
The Mexico Fund is a CEF focused on Mexican investments. The MXF fund appears well managed, as it has outperformed the MSCI Mexico Index on a 3, 5, and 10Yr basis. Mexico is benefiting from a shift in investment flows out of China, as American companies look to shorten and retool their supply chains. I expect the MXF fund will continue to outperform in the next few years based on this global shift in capital.
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Mexico Fund: Benefiting From Frosty U.S.-China Relations