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S&P Credit Upgrade Boosts Philippines ETF

Zacks Equity Research

As the domestic market remains listless thanks to a host of issues like the slow-yet-steady QE wrap up, stretched stock market valuation and the resultant correction in growth stocks as well as measly growth in Q1, many investors have harbored in foreign ports in search of better investment options.

With European recovery still dubious and major emerging markets like China showing little hope for a rebound, some have turned to smaller—and often overlooked—nations like the Philippines for growth opportunities. These investors have concrete reasons for moving towards the Philippines as the nation has given a star performance this year defying the gravity of an emerging market sell-off.   

Strong economic growth, a stable currency as against many of its emerging market cousins, a decent current account balance and a sound forex reserve helped by considerable contribution from remittances from abroad created a winning combination.  If this was not enough, recently this island nation was rewarded with a credit rating upgrade, which is now two marks above investment grade, by S&P (read: Solid Growth Puts Philippines ETF in Focus).

Inside the Credit Rating Upgrade

Recently, the S&P raised the long-term sovereign credit rating of the Philippines by one notch to BBB from BBB- and inferred a stable outlook. The agency attributed the upgrade to President Benigno Aquino’s initiatives to bolster the nation’s ‘economy and government’.  

The S&P said, “we believe the resulting gains in government revenue generation, spending efficiency, and the improvement in public debt profile and investment environment will at least be preserved in the medium term’’.   
As per CNBC, the Philippines came out of a long stretch of junk-debt grade in 2013 receiving a investment-grade status initially from Fitch Ratings, then by the S&P and finally by Moody's Investors Service.

Notably, the nation’s government debt-to-GDP ratio of 49.20% in 2013 can be touted as quite respectable against many of its emerging market peers, and especially so against many of its developed market counterparts (read: Russia ETFs in Focus on Credit Downgrade, Rate Hike).

Market Impact

Needless to say, the recent upgrade added fuel to the ongoing stock market rally. The nation’s benchmark stock index had already seen a 15% jump this year and remains one of the winners in the Asian markets, per the Bloomberg data. We believe the Philippine stock market is due for another run in the weeks ahead too (read: 3 Emerging Market ETFs Off to a Great Start in 2014).  

Aided by this extreme bullish fundamental, a pure play on the Philippine market – iShares MSCI Philippines Investable Market Index (EPHE) – has surged around 18% year-to-date. The fund has been doing particularly well lately, possibly as a reflection of the S&P upgrade (read: Is the Philippines ETF Back on Track?).

EPHE in Detail

Launched in September 2010, this ETF looks to track the MSCI Philippines Investable Market Index. The fund invests about $370.5 million of assets in 44 securities. The financial sector takes the top spot in the fund with about 36% exposure and is closely followed by industrials (26%). No other sector gets a double-digit allocation in the fund.

It is worth noting that the fund has considerable concentration risk with about 57.62% of assets invested in the top 10 holdings. Ayala Land (8.9%), Universal Robina Corp. (6.4%) and Philippine Long Distance Telephone (6.4%) comprise the top three holdings. 

The fund charges an expense ratio of 62 basis points. EPHE lost about 7.93% in 2013. Over the last one month, EPHE gained about 5.7% while iShares MSCI Emerging Markets ETF (EEM) added about 1.39%. EPHE currently has a Zacks ETF Rank #3 (Hold) with a medium risk outlook.

Bottom Line

However, all is definitely not well with the nation. The S&P indentified the Philippines' low income level as a major limitation for the medium term, with per capita GDP forecast of $2,900 for 2014, much below the sovereigns with similar ratings. The agency also found some disparity in its tax structure and infrastructure amenities. 

Also, following a stunning rally this year, EPHE has become a little overvalued when compared to other high-potential southeast Asian funds like iShares MSCI Malaysia ETF (EWM) and iShares MSCI Indonesia (EIDO). EPHE’s trailing twelve month’s P/E is at present higher than both EWM and EIDO. EPHE is also about to enter overbought territory as evident by the relative strength index of 69.82.

Still, the trend is in favor of the Philippines as very few other emerging nations are forecasted to log more than 6% GDP growth rate in 2014. Also, a favorable credit rating calls for lower borrowing costs which will likely give another boost to the nation’s growth, and so to the in-focus ETF described above as well.

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