2023-04-21 17:44:01 ET
Summary
- Peru, and thus iShares MSCI Peru ETF, may not outperform as well as it did in 2009 and 2010.
- The market still trades at a premium to Colombia and Brazil.
- Political risks could result in a pullback in the market, hurting iShares MSCI Peru ETF.
Opportunity Overview
Peru is an intriguing, relatively high-yielding emerging market that may be worth exploring if you want long-term exposure to emerging markets. The iShares MSCI Peru ETF (EPU) invests in cyclical industries like mining and materials, which could perform well in the coming years. Equities are relatively cheap at the moment due to political and macroeconomic risks. However, I think the discount in markets like Brazil and Colombia is more intriguing, especially as investors are concerned with political risks in all three countries. Peru will face many economic challenges this year and may not benefit from higher commodity prices as it did in 2009 and 2010 when it drastically outperformed other emerging markets. At the moment, I think Peru is a good hold, while regional peers like Colombia and Brazil could be better buys.
Peru and Copper Exports
One of the main benefits of investing in Peru in this cycle is that the economy has historically benefited from rising copper prices. However, Peru's copper exports recently grew by 20% during the first two months of this year, even as production rose. However, Peru's copper exports have consistently risen every year in the past decade before this, and exports still increased by 3% in 2022. In the past, declining copper prices made Peru's economy very vulnerable, as it resulted in slower growth and a widening current account deficit. Peru recently ran a favorable account surplus in 2020 and has since had a CAD since 2021 .
CA Balance
The IMF projects that growth in Peru will fall below 3% in 2023 , and the economy remains vulnerable to key issues like rising inflation, political risks, and commodity price fluctuations. There is still no political clarity at the moment, as elections for 2024 have not been confirmed, and Castillo was removed from office last December. Peru's inflation rate has remained below 10% since the 1990s but is now beginning to approach a new high. Consumer confidence recently dropped to a multi-decade low last year.
Inflation in Peru
Regional Comparison: Valuation and Performance
One factor to note is that Peru trades at a premium to other regional emerging markets, despite the country also having significant political risks. Even this exchange-traded fund ("ETF"), which trades at a discount to MSCI Peru, trades at a premium to all three of these markets.
Index | P/E | P/B |
MSCI Peru Index | 11.83 | 1.70 |
MSCI Brazil Index | 5.07 | 1.41 |
MSCI Colombia Index | 5.20 | 0.86 |
MSCI Chile Index | 5.00 | 1.25 |
Source: MSCI.
While I am not making a bet on which country has the best/worst political stability, I think it could be more logical to bet on some of these other markets based on the following:
- All three markets trade at a relative historical discount due to higher perceived political risks, often involving uncertainty over elections/political transitions.
- All four of these economies are poised to benefit from higher commodity prices due to their export structures.
- The industry breakdown of these ETFs is relatively similar. Most are overweight cheaper themes like energy, materials, and finance.
Peru has been able to outperform all of these markets in the past three years, despite the abundance of political risks. Colombia has been one market that has massively underperformed in the short term, breaking the trends seen until H2 2022.
On a long-term horizon, Peru also consistently performed in all of these emerging markets.
ETF Overview
This ETF is a relatively larger fund (over $120mn assets under management, or AUM) that invests in a basket of under 30 companies with significant operations in Peru. This vehicle provides exposure to Peru's stock market, which is relatively harder to access as the combined stock market capitalization is below $100bn . This ETF is a convenient option, as there are only three Peruvian ADRs listed on the NYSE.
This ETF trades at around 9.46xPE and 1.47x PB, which is a slight discount to the MSCI Peru Index. It charges a 58 basis point management fee, and the current yield is around 5%.
Peru has a very small weighting in MSCI Emerging Markets, and the MSCI Peru Index only has three companies. Many emerging market investors overlook Peru because of this fact.
Equities in Peru have more or less flatlined since Covid
Peru has underperformed emerging markets by around 12 percentage points in the past five years.
Notes on Sectors
If you choose to invest in this ETF, you will have strong exposure to mining companies, some of which are not listed in Peru. Around half of the ETF's assets invest in materials companies.
Southern Copper Corporation (SCCO) is the ETF's largest holding and accounts for around 23% of the ETF's assets.
As seen below, equities in Peru previously moved in line with the Global X Copper Miners ETF (COPX), until the 2020s when copper began to outperform on the back of supply issues.
In my view, it is less likely that Peru will mimic its 2009-2010 stellar performance if economic conditions are poor and copper exports still lag, even with demand from China returning as the economy reopened.
Peru has had exceptional performance in many years, including 2016 and 2017. However, it still may be challenging for Peruvian equities to deliver similar performance, even if commodities boom, due to the unique political and macro risks present.
Risks and Final Thoughts
One of the key risks for investors to monitor includes the political risks in the country this year, as the current government is not very popular and sentiment could become worse after the next election. Moreover, the political protests in the country have the potential to disrupt the mining industries in Peru. The country's mining exports represent around 64% of the country's total exports.
The previous political protests in Chile in 2019 are one of several reasons why Peru outperformed Chile following 2019. However, new political risks in Peru could reverse this trend.
Rising political risks could also cause the currency to experience pressure, which would negatively impact equity markets, even as copper prices improved. Peru's foreign exchange reserves are relatively high, equivalent to 30% of GDP and covering over 14 months of imports as of the end of 2022.
My rating for Peru, and thus iShares MSCI Peru ETF, is neutral mainly because of the relative value in regional markets, and the opportunity for new political risks and economic risks to emerge in 2023 and 2024.
For further details see:
iShares MSCI Peru ETF: How This Fund Stacks Up To Regional Peers