The iShares MSCI Peru ETF (NYSE: EPU), the only U.S.-listed exchange traded fund dedicated to Peruvian equities, is up 3.2 percent to start 2018. That is an admirable showing when considering the country's recent bout of political volatility.
After pardoning former President Alberto Fujimori last month, current President Pedro Pablo Kuczynski was nearly impeached. Peruvian stocks tumbled through November and part of December, but EPU finished 2017 up 29.7 percent, trailing the MSCI Emerging Markets Index by 760 basis points. In its favor, EPU has rallied off its December lows and resides just 1.1 percent below its 52-week high.
“A political crisis boiled over in December 2017 when President Pedro Pablo Kuczynski abruptly pardoned former President Alberto Fujimori three days after Kuczynski barely maintained office in a rapid impeachment vote on Dec. 21,” said Fitch Ratings. “The pardon generated peaceful public protests across Peru, prompted the resignation of ministers and top advisers and alienated a segment of the president's electoral base, weakening the president's political mandate. His approval rate was 25 percent at year-end, according to an Ipsos poll.”
Political Volatility Could Sap Growth
Political volatility is often a concern for investors when considering emerging markets. In the case of Peru, that volatility could weigh on economic growth after the country posted several years of some of the steadiest growth in Latin America.
Over the past three years, EPU's annualized volatility is only slightly higher than that of the MSCI Emerging Markets Index and well below that of the S&P Latin America 40 Index. However, EPU's maximum drawdown over that span is 820 basis points higher than the emerging markets benchmark.
“Political tensions between President Kuczynski and the Fujimoriista-led congress pose governability challenges and have paralyzed the prospect for major judicial, labor or pension reforms,” said Fitch. “Although recovery in the mining industry should lift growth to a degree, Fitch expects to revise the economic growth forecasts for 2018 and 2019 lower than the 4 percent and 3.4 percent, respectively, expected in early December.”
Peru is a major producer of copper and gold and one of the world's largest silver producers — factors reflected in EPU as the ETF allocates about half its weight to the materials sector. Higher prices for industrial and precious metals could buffer EPU against political shocks this year, but risks linger.
The political events could undermine Peru's ranking on the World Bank Governance Indicators survey (an important variable in Fitch's sovereign rating model), as a result of weaker public perceptions of the rule of law, control of corruption and political stability,” said Fitch. “Lower economic growth could slow the convergence of per capita income with the 'BBB' median.”
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