Inaccessible Markets: Which Frontier And Emerging Countries May Soon Be Tracked By More ETFs

Of the 24 countries classified as emerging markets by MSCI, there are 13 which have only a single dedicated ETF available to US investors. The list includes major markets like South Africa, which houses the sixth largest stock exchange in emerging markets and has a market cap of over $1 trillion.

The iShares MSCI South Africa ETF (EZA) – the only ETF tracking the South African market that is traded on US exchanges – tracks the MSCI South Africa Index, which is comprised of 53 constituents. There are no sector or theme-based funds tracking the market even though there are 18 indices on the local exchange, according to Bloomberg data.

The MSCI South Africa IMI Index, which has 111 constituents across various market caps could be an interesting option for an ETF with an even broader based exposure to a market which is currently underrepresented.

It’s not to say that ETFs investing in South Africa or other countries with just one dedicated fund like Chile are not attracting investor interest. Aside from the six largest Chinese ETFs out of the 31 funds focused on China (KBA) (PEK), the EZA and iShares MSCI Chile Capped ETF (ECH) are bigger than all others. They are larger than ETFs investing in Argentina (ARGT) (AGT) and Colombia (GXG) (ICOL) as well, both of which have two ETFs each tracking their markets.

In the graph above, single country ETFs like that for Turkey (TUR), Thailand (THD), and a frontier market like Vietnam (VNM) all feature among the largest funds in this segment.

Untouched corners

The MSCI country indices for Hungary and Czech Republic, both emerging markets, have done well in YTD 2017, having returned 35% and 18% respectively. However, there are not currently ETFs listed on US markets that would allow investors to partake in the strong performance of these countries.

The broad-based fund route does not help either. The most exposure one could get for these countries is 4.7% for Hungary and 2.5% for Czech Republic.

As far as frontier markets are concerned, there are only three countries with dedicated ETFs out of the 33 that MSCI classifies in that category – Argentina, Vietnam, and Nigeria.

Time for a relook?

There remains noticeable pockets in the frontier and emerging markets universe that can be turned into investment avenues.

Investor interest should not be a big hurdle, as the lone ETFs tracking some of the larger markets have had good traction and are considerably larger than a majority of funds tracking much bigger and popular markets.

The launch of the AGT in April this year made Argentina the first frontier market to have two ETFs tracking it. Its asset size growth would be of interest to fund companies looking at launching single-country funds for similar or even larger markets except for China, India, and Brazil.

Thus, it may be time to relook at the present offerings and think about deepening the number and scope of offerings for markets which have done well over the medium to long-term and can thus find traction.

These Are The 5 Equities Holding The Peruvian Stock Market Back In 2017

Peruvian equities have been facing a number of headwinds in 2017. After a strong start to the year which saw the iShares MSCI All Peru Capped ETF (EPU) climb 11% by early February, the ETF has lost a lot of ground and is up only 4.4% for the year to June 22.

This performance places it better than only Brazil among the five countries included in the MSCI Emerging Markets Latin America Index.

The iShares MSCI Brazil Capped ETF (EWZ) is nearly flat for the year. Its performance has driven down the entire EM Latin America Index as it forms a mammoth 55.5% of the exposure of the Index. Meanwhile, Peru forms only 2.9% – the smallest allocation of the five countries.

The EPU is neck-and neck with the Global X MSCI Colombia ETF (GXG) and far behind the iShares MSCI Chile Capped ETF (ECH) and the iShares MSCI Mexico Capped ETF (EWW).

The stocks which have hurt the EPU

Industrials is the sector which has hurt the fund the most so far in 2017. Of the two holdings from the sector, engineering and construction major Graña y Montero S.A.A. (GRAM) has been the biggest negative contributor to the fund. In terms of total returns, the stock has plummeted 54.7% in YTD 2017 (in Peruvian Sol terms). However, since it forms only approximately 2% of the fund, the impact has been somewhat contained.

The second biggest negative contributor comes from the consumer staples sector. Multi-format retailer InRetail Perú Corp is one of the three holdings from the sector in the EPU and forms 3.1% of the fund. The stock is down 8.8% on the year, and has dragged down the positive contribution by the top holding from the sector – Alicorp S.A.A.

The third worst performer in 2017 so far comes from the materials sector. FOSSAL S.A.A. is a spin-off from cement-maker Cementos Pacasmayo S.A.A. (CPAC). The stock is no longer part of EPU’s portfolio, but its poor performance this year still makes it the third largest negative contributor to the fund.

The next two poorest performing stocks come from the utilities sector. Utilities follow industrials as the second worst performing sector with both holdings – Luz del Sur S.A.A. and Enel Distribución Perú S.A.A. in that order – dragging on the fund.

Let’s look at the headwinds which have held Peruvian equities back on a broader level in the next article.

Last To the Party: Colombia Could Turn A Corner After Its Slowest Quarter Since 2009

Though Late, Colombian Stocks Have Joined the Emerging Markets Rally

Up until very recently, Colombian stocks told an underwhelming story of late. As recently as May 4, the MSCI Colombia Index had risen just 3.6% for the year, garnering limited attention at a time when the Emerging Markets Latin America Index was up 10.7%, and the broader Emerging Markets Index had gained 13.7%.

However, since then, things have changed quite a bit. So much so, that the Colombia Index was up 11.25% as the month of May drew to a close. The country has now bettered the Emerging Markets Latin America Index, which was up 9.6% in the same period.

ETF performance

The recent rise in Colombian equities merits a closer look at the following ETFs:

  • iShares MSCI Colombia Capped ETF (ICOL)
  • Global X MSCI Colombia ETF (GXG)

Financials, utilities, and materials, in that order, have helped these two funds post their double digit gains this year.

While the regular and preferred shares of Bancolombia S.A. (CIB) have helped ICOL, the sponsored ADR has powered the GXG.

The utilities sector across both funds has been led by Interconexión Eléctrica S.A. E.S.P. (IESFY). The company’s stock had reached an intraday high of 13,900 pesos on May 26 – a level not seen since January 2011 – due to reduced regulatory risk.

View on Colombian stocks

Colombian ETFs have not yet attracted significant investor interest from the US. Though the Colombia-listed iShares COLCAP Fund, the first and largest local equity ETF available in Colombia to all investors, has attracted inflows worth $150 million in YTD 2017, the two US-listed ETFs have only attracted a combined $1.5 million with GXG attracting $822,500 YTD according to Bloomberg data.

The ICOL is only slightly more expensive than the iShares MSCI Brazil Capped ETF (EWZ) but much cheaper than the iShares MSCI Mexico Capped ETF (EWW). While Brazil is undergoing a political crisis, Colombia has been making progress on its peace deal with rebel group FARC.

Macro economically, the country’s economy rose just 1.1% in Q1 2017 – the slowest pace since 2009 – mostly due to the fact that mining production shrank by 9%. However, many are considering this to be a bottom for the country as construction activity is expected to pick up. If oil prices remain firm, they will also help the economy.

Meanwhile, there are mixed views from analysts regarding Colombia stocks. According to reports by Bloomberg, HSBC analysts have added CIB to their model Latin American portfolio. On the other hand, Citigroup has kept Colombia at ‘underweight’ citing that it is “too hard to find conviction ideas at reasonable prices.”

For investors taking the ETF route, the broad-based ETF basket would help mitigate risks that come along with investing in individual stocks.

The Greatest Risk Facing Latin American Economies Is the One We Cannot See

The risk we cannot see

Latin American equity has been a strong performer thus far this year. The iShares Latin America 40 ETF (ILF) has returned 12.7% so far this year (as of March 23), an outsized driver of emerging market (EEM) (VWO) performance. The rally, driven by the commodity price rebound has been instrumental in driving up the stock market. The market upswing and the continued preference for emerging market debt seems to indicate that investors in the Latin American economies are shrugging off the near-term risks posed by the Trump administration.

[stockdio-historical-chart stockExchange=”NYSENasdaq” width=”100%” symbol=”ILF” compare=”EEM” displayPrices=”Lines” performance=”true” from=”2017-01-01″ to=”2017-03-23″ allowPeriodChange=”true” height=”350px” culture=”English-US”]

Pockets of uncertainty

However, the greatest risk facing the Latin American economies is the one we cannot see, said Arthur Rubin, Head of Latin America Debt Capital Markets, SMBC Nikko Securities America, Inc., during a March 23 interview with Bonds & Loans. There remain pockets of uncertainty, says Rubin. “The new norm under the Trump administration maybe pockets of uncertainty, driven by unpredictable and unforeseen policy initiatives that don’t really last that long.” The markets are already pricing in the rate hikes expected in the U.S. However, in the event of a policy occurrence beyond the expected, emerging markets such as those placed in Latin America, stand more exposed to risk of possible repercussions.

Local-debt winning investor favor

While Rubin does agree that the volume of international debt issued globally is on the rise, he doesn’t see Latin American economies such as Colombia (GXG) (ICOL), Peru (EPU), and Chile (ECH), taking the plunge, just yet. Credit spreads, which are beginning to tighten for many economies, are still wide enough for certain LatAm economies.

Local currency emerging market debt is already flying high amid U.S. policy reshuffle. The current and expected U.S. policy reshuffle including monetary policy tightening, along with protectionist curbs are expected to strengthen the U.S. dollar (UUP), which works against holders of emerging market (EEM) (VWO) dollar-denominated debt which gets expensive with a rising dollar. This is when local-currency debt takes center stage as the instrument that is immune to such policy risk.

What Could Make Dollar-Funding an Attractive Option in Colombia?

Peso funding continues to be attractive in Colombia

There’s a perception that credit conditions tightening in Colombia (GXG) (ICOL) will cause borrowers to begin to look towards dollar funding. However, SMBC Nikko Securities America sees peso funding continuing to be attractive and sufficient, at least for now. If growth in Colombia starts moving up to around 3 or 4%, such that demand for credit becomes more robust, then we could see the constraint showing up, said Arthur Rubin, Head of Latin America (ILF) Debt Capital Markets at SMBC.

What could make dollar-funding at attractive option?

  1. The need for international funding should arise only when we see sustained high levels of economic growth in the region, which is when we would also witness a rise in local funding cost, and credit spreads between local and international funding, tightening.
  2. Moreover, with the markets already pricing in the two 25 basis point increases by the Fed this year, it would only take an unexpected occurrence, to make dollar-funding attractive for countries like Colombia (ICOL), Peru (EPU) and Chile (ECH).

For now, dollar-funding isn’t as compelling an option

For now, credit growth in the corporate sector in Colombia has been declining, keeping any stress on bank liquidity at bay. We are still seeing a number of Colombian peso bonds being floated. Large borrowers such as utilities and consumer firms are able to secure peso funding domestically. Moreover, local-currency funding continues to prove more attractive in cost terms as compared to dollar-funding.

“The need to diversify funding sources in both Peru and Colombia, hasn’t really been there,” said Rubin. “With domestic capital markets and local-currency funding being able to suffice the funding needs arising in Colombia and Peru as of now, going abroad for dollar-funding isn’t as compelling an option.”

Why The US-Colombia Trade Agreement Has Not Been Attacked

So far, Colombia is safe

Unlike its Latin American counterpart Mexico, Colombia (ICOL) has not been mentioned explicitly by the new US administration when it comes to trade. The US is the largest export destination for Colombia. The two countries already have a trade agreement known as CTPA (United States-Colombia Trade Promotion Agreement) which was signed in 2006 and has been in force since 2012.

As far as goods trade is concerned, the graph below will shows that for the most part, the US has had a goods trade deficit with Colombia, though it enjoyed a trade surplus in 2014 and 2015. This may be part of the reason why the Trump administration has not attacked the CTPA — at least so far.

However, this is not to say that Colombia (GXG) will be immune to the Trump Administration’s views on trade protectionism.

The Colombian peso has tanked, along with several emerging market currencies after the US  presidential elections in November, going beyond the 3,100 pesos to one USD. However, the announcement of a crude oil production cut by OPEC and non-OPEC members helped support the peso and it is now trading at 2,850 to one USD. Increased oil prices (USO) are also expected to support the peso.

Not worried on trade

There are two reasons why Colombia is not excessively worried about the terms of its bilateral trade with the US.

First, as seen from the figures provided in the above graph, the size of overall trade – when looked from the perspective of the US – is low. As the US administration allocates resources to attacking countries with larger trade deficits such as Mexico and China, Colombia would find itself quite low on the list of priorities.

Secondly, Colombia is a close ally of the US when it comes to the war on drugs. With hopes of ensuing peace after coming to terms with FARC (Revolutionary Armed Forces of Colombia), the country would expect cordial relations with the US to continue.

Pacific Alliance comes together

At the same time, Colombia is supporting Mexico, along with Peru, another Pacific Alliance member, as far as trade restrictions by the US are concerned.

Colombian President Juan Manuel Santos was reported by the New York Post as saying “We want to join the call of countries that adhere to the principles that have been so good for the world: free trade, respect for treaties… multilateral solutions.”

This solidarity with its Latin American trade partners is to ensure that its stance on trade protectionism is known, but is diplomatic enough not to irk the US. In an uncertain world, Colombia will likely give priority to its strong political and economic relationship with America.

In the next article, we’ll look at an emerging market in Europe which is keep a close watch on US trade policy.

Colombia ETFs Return Over 30% In Past Year Despite Vulnerabilities

Colombia’s vulnerabilities: oil price, Donald Trump and dollar-debt

Colombia is another country whose vulnerability to the rising US dollar (UUP) stems from the fact that over 90% of the economy’s external debt is dollar denominated. If the US dollar appreciates further into 2017, this debt could become more and more expensive for this Latin-American (ILF) economy to repay.  Colombia currently holds about $40 billion in external debt, of which over 90% is US-dollar denominated.

[stockdio-historical-chart stockExchange=”NYSENasdaq” culture=”English-US” width=”100%” height=”350px” symbol=”GXG” compare=”ICOL” displayPrices=”Lines” performance=”true” from=”2016-01-29″ to=”2017-01-29″ allowPeriodChange=”true”]

Like Venezuela, the economy of Colombia is vulnerable to the price of oil, whose exports accounts for about 50% of the country’s total exports. According to Colombia’s largest bank, Bancolombia, “For 2017, we expect volatility in the Latin American exchange markets to remain high, reflecting political uncertainty, the advances of the Donald Trump government, the [U.S. Federal Reserves] price increases, and the uncertain trajectory of commodity prices.”

The peso’s slide may continue

The Colombian peso is already down by almost 50% over the past five years. The slide accelerated in mid-2014 with oil prices dropping, only to take a breather in February last year. However, the peso remains weak, and with President Donald Trump’s protectionist measures and monetary policy tightening in the US, we may see emerging market (EEM) currencies such as the Colombian peso remaining weak.

A stronger dollar, coupled with low oil prices could soften the Colombian peso further. A weaker peso could fuel inflation in the economy (by making imports expensive), which stood at 5.75% in December 2016. The economy runs a $1.47 billion as trade deficit (November 2016), and growth remains weak at 1.2% as of 3Q16, from highs of 6% in 2014. Unemployment in the country stands at 8.7% currently.

Investment products

Despite the turbulence, funds such as the Global X MSCI Colombia ETF (GXG) and the iShares MSCI Colombia Capped ETF (ICOL) which have exposure to Chilean equity have returned 34% and 30.6%, respectively, over the past 1 year.

The economy is expected to grow 2 percent this year, close to the 1.8 percent estimated for 2016. Analysts and fund managers believe central bank stimulus measures may be required to keep the momentum.

Which Three LatAm Countries Will Get Hit The Hardest If The Dollar Appreciates Further?

Overweight India, Underweight these countries

While Europe’s third largest fund house is overweight India, others are busy pulling out of emerging market (EEM) (VWO) economies. As the US shows signs of growth and inflation, we may soon see institutional investors going underweight on them. Of particular note will be those emerging markets that are vulnerable to the US dollar’s appreciation.

The markets broadly expect the dollar to appreciate amid the US Federal Reserve tightening monetary policy in the US combined with President Donald Trump’s protectionist policy changes. With the US dollar appreciating, countries with a whole lot of dollar-denominated debt on their balance sheets could land in thick soup.

3 economies that would be most affected

In this series, we look at three such economies that stand to be most affected if the US dollar (UUP) appreciates. All of these fall in the Latin American (ILF) region. According to our analysis of data composed by Macquarie Research, these three emerging market economies would get hit the hardest if the US dollar appreciates as we move ahead into 2017. These countries hold the highest US-dollar denominated debt as a percentage of their total external debt.

The top three economies with the highest amount of US-denominated debt as a percent of their total external debt are Venezuela, Chile (ECH), and Columbia (GXG).

As these countries stand first in line to fall under the brunt of a rising US dollar, let’s take a deeper look at what the economic scenario in each of these nations. For investors searching for higher yields accompanying these riskier countries or considering potential short positions, we would also look at certain investment products.