Behind the Crash in Brazil ETFs

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Brazil, the largest South American country, has long been in the limelight from a tourism perspective thanks to its beautiful sun-kissed beaches and vibrant nightlife. However, the country has hit some hard times lately and many are now reevaluating their perceptions of the nation.   

The mess in Brazil

Brazil will host the FIFA World Cup in 2014 and the Summer Olympics in 2016, both of which demand huge investments in areas such as urban and social development as well as transport infrastructure. Many had hoped that the surge would provide jobs and improve basic infrastructure, but those issues are now outweighed by budgetary concerns.

There have been recent hikes in bus fares and reductions to other social services, leaving many to wonder why so much is being spent on sporting events when there are plenty of other problems in Brazil. In fact, the bus fare hike sparked a huge protest across the nation with millions of Brazilians taking to the streets and forcing President Dilma Rousseff to call an emergency meeting about the situation.

If that wasn’t enough, Brazil’s inflation sprung up to 6.5% in the last 12 months through May. Meanwhile, the Brazilian currency, the real, was hit hard by Fed’s bond buying program and the Brazilian government’s easy monetary and fiscal policy (See Brazil ETFs Crushed by Downgrade, Currency Woes).

Impact

This terrible situation has led to a near crash in Brazilian stocks as of late. The country’s main BOVESPA index was at over 60,000 to start the year, but has since plummeted below 50,000, with the vast majority of the losses coming since the start of May.

There has been some hope for the future though, as Rousseff called for a national referendum in order to soothe citizens, and investors, about the country’s precarious state.

Did the President’s Referendum Offer allay investor fears?

Unfortunately, the president’s offer to address issues of corruption, education, health care and poor public transport has made little impact on disgruntled protesters. On June 26, about 50,000 protesters marching towards a football stadium clashed with the police, suggesting that the story might have a bit more room to run.

Outlook/ Funds to watch

Analysts believe if government reform and stringent policies are not urgently implemented, the economy will be in the doldrums for quite some time. It doesn’t help that there has been broad BRIC market weakness as well, suggesting that the trend isn’t your friend in many major emerging markets for the time being (See Forget Brazil ETFs, Focus on This Top Ranked Fund Instead).

Given this and the extreme volatility afflicting the Brazilian economy, investors may want to play close attention to some of the key ETFs targeting the space. These funds could be in for a rocky ride over the next few weeks so investors may want to keep an eye on the space either for a bottoming out, or for further losses in this important market:

iSHARES MSCI BRAZIL CAPPED INDEX FUND (AMEX: EWZ)

Launched in July 2000, EWZ seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI Brazil 25/50 Index. EWZ is a passively managed large blend fund with an AUM of more than $6 billion (see The Comprehensive Guide to Brazil ETFs).

The ETF holds 81 stocks and the top 10 stocks contribute about 49% to the fund. The product also has a focus on large caps, as these account for 56% of the portfolio, with mid caps making up much of the rest.

EWZ charges 60bps in fees, lower than the category average of 71bps. The fund has  experienced a pretty rough 2013 so far, losing about 20% of its value since the start of the year.  

The ETF currently has a Zacks ETF Rank of ‘4’ or ‘Sell’.

iSHARES MSCI BRAZIL SMALL CAP INDEX FUND (AMEX: EWZS)

Launched in September 2010, EWZS seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI Brazil Small Cap Index. The small blend fund is passively managed and has an AUM of $39 million.

With a total of 85 holdings in its basket, its top 10 stocks contribute 31% of the total. Investors should also note that despite the small cap name, more than half of the product is actually in mid caps, with 43% going to small caps

The fund charges 60bps in fees, putting it in line with its large cap counterpart. The product has also struggled so far in 2013, losing just under 23% in the time frame.

The Bottom Line

Brazil clearly has a lot of problems afflicting its market, both from a general perspective, as well as some localized political issues. Both of these trends seem to be in place for quite some time though, so there may be more pain ahead for the country (Winning ETF Strategies for the Second Half).

Due to this, investors should definitely watch out for volatility in the market and pay special attention to EWZ and small cap counterparts. These funds should give investors a good idea of how the Brazilian market is heading, and if any bottom is coming in this troubled nation.

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