Brazil is a hot emerging market that many investors want to add to their portfolio. However, with the rewards of Brazilian investments also come significant risks.
GDP in Brazil is growing at the rate of about 5% per year even as the rest of the world struggles. However, inflation accelerated for the 12th straight month in August to its highest annual rate since 2005. The growth in Brazil thanks to its emerging middle class is impressive, but not without challenges.
If you think the benefits of Brazil outweigh some of the risks, there are a couple ways to play this emerging market to maximize your profits.
Investors looking abroad to seek greater returns in growing economies without relying on actively managed strategies may be well rewarded by acquiring a position in the iShares MSCI Brazil Index (NYSE:EWZ) ETF. This is an ETF that represents a portfolio of stocks issued by companies in Brazil. The strategy is benchmarked to this index, and corresponding changes will occur as the benchmark is adjusted.
The top 10 holdings are:
- Petrobras (NYSE:PBR) preferred shares, 10.7%
- Vale (NYSE:VALE) preferred shares, 9.97%
- Petrobras common shares, 8.4%
- Itau Unibanco (NYSE:ITUB), 7.79%
- Vale common shares, 6.96%
- Banco Bradesco (NYSE:BBD) preferred shares, 5.73%
- Ambev (NYSE:ABV) preferred shares, 3.71%
- Itausa — Investimentos Itau SA, 2.68%
- Brasil Foods (NYSE:BRFS), 2.15%
- BM&F Bovespa SA, 1.93%
The remaining 40% or so of the portfolio is invested in 76 other companies.
Obviously, EWZ is not that diversified within the country, since about a third of the fund is focused on Petrobras and Vale, via both preferred and common stock. Petrobras is Brazil’s largest company in terms of market capitalization and holds the eighth spot in the world. The focus of the business is the exploration and transportation of oil and natural gas. Vale is a mining company that explores and develops natural resources such as iron ore, copper, nickel and aluminum.
This ETF strategy offers considerable rewards. But there are significant risks included that the average U.S. investor should consider before purchasing shares. The exposure to industries focused on natural resource exploration is obvious when looking at the top holdings. What is not readily seen is the currency translation from the Brazilian real to the U.S. dollar. There has been significant fluctuation in the exchange rate between these two currencies, which will contribute to the performance of the share price of this ETF.
If you are very bullish on Brazil, the use of leverage to generate returns could supercharge your profits. The ProShares Ultra MSCI Brazil (NYSE:UBR) ETF seeks to generate two times the daily returns of the iShares MSCI Brazil Index. Of course, that means when the related EWZ slumps, you lose twice as much on the downside, too.
It’s also worth noting that it’s not an exact 2-to-1 ratio between EWZ and UBR. Frequent trading by management of this ETF will lead to increased transactional costs. The prospectus details that the operating expenses the investors pay is capped at 0.95% of assets. Further investigation into the operating expenses finds that the ongoing trading within this fund is approximately 11.25% with a waiver and reimbursements agreement reflecting an offset 10.2%. So costs eat into a portion of your “doubled” profits.
And of course, the same risks of currency fluctuations and other economic issues specific to Brazil remain in this fund as with the iShares MSCI Brazil Index ETF.
For the investor that has the skills and techniques to conduct day trading or short-term long/short speculation, the leveraged ETF might provide better Brazil returns. However, all other investors are advised to stay away from this ETF and focus on the straight EWZ fund to play Brazil.
Jeffrey L. Stouffer owns no direct or indirect holdings in these ETFs.
Jeffrey L. Stouffer is the principal of Mercantile Capital Group, a Herndon, Va.-based introducing broker registered with the CFTC and a member of the National Futures Association. He can be reached at email@example.com.