Brazil ETF's Compared with the South America Focus Portfolio

In this article, we give details on Brazil ETF's traded on the NYSE, and compare their performances with that of the South America Focus portfolio offered by Covestor Investment Management (CVIM) for US and global investors. You may read more in our coverage of this South-American and Brazilian stock portfolio.

Brazil ETF's

	iShares MSCI Brazil Index	Market Vectors Brazil Small-Cap ETF	Brazil Infrastructure Index	Ultrashort MSCI Brazil
Ticker (NYSE)	EWZ	BRF	BRXX	BZQ
Assets under management ($M)	8,552 (1)	716 (2)	20 (4)	48 (4)
Type	Large & medium cap	Small cap	Infrastructure stock	2x-leveraged inverse
Inception date (1)	7/10/2000	5/1/2009	2/24/2010	6/16/2009
Exchange	NYSE Arca
Current net expense ratio (1) (7)	0.65%	0.71%	0.85%	0.95%
Trailing 5yr annualized return (4)	24.41%	(5)
Trailing 1yr return (4)	20.25%	53.25%	(5)
Top holdings	19.8% Petrobrás 17.6% Vale 8.3% Itaú Unibanco (2) (6)	6.2% Lojas Renner 4.9% Sul America 3.9% CETIP (1)	6.0% Vale 5.8% Cia Sider. Nacional 5.6% Cia de Conc. Rodoviarias (3)	99% MSCI Brazil Swap (1)

(1) As of May 25, 2010, as informed on the fund's Web page.
(2) As of April 30, 2010, as informed on the fund's Web.
(3) As of March 31, 2010, as informed on the fund's Web page.
(4) According to Morningstar, as published on May 25, 2010, AMC.
(5) Its history is not long enough for this performance analysis.
(6) The allocations in Petrobrás preferred and common stock were consolidated, as well as Vale's.
(7) In some cases, these expense ratios are the result of contractual caps that have expiration dates. Rates may rise when these caps expire, please read the funds' prospectus for further details.

The table above shows data for the four Brazilian ETF's traded in US exchanges. The largest one is iShares MSCI Brazil Index (EWZ), that covers large and mid-cap stock, has been around for several years and adds to more than eight billion dollars in assets. EWZ is often criticized for having too much of its portfolio allocated in two companies: giants Petrobrás (oil) and Vale (mining). The other two long funds, Market Vectors Brazil Small-Cap (BRF) and the new Brazil Infrastructure Index (BRXX), have more company diversification. Nevertheless, BRF is focused on small-caps and BRXX on infrastructure-related stock, which leads to some observations as well.

Small-cap stocks tend to be more volatile than large-caps, and normally offer slightly better returns in the long term, in exchange for that additional risk. But the problem with replacing EWZ with BRF is that the latter does not include interesting plays like Petrobrás, Vale and the largest banks in the country, although its assets are better distributed between company and sectors. It is of interest to consider an allocation that combines both ETF's, which would result in better diversification at little additional cost.

On the other hand, BRXX has a focus that excludes Petrobrás, large banks and some other promising companies, which, at first sight, looks like a hindrance. Nevertheless, the included sectors are decent diversifiers among themselves, because they include various themes such as telecommunications, iron mining, steel, utilities, road construction, aircraft exporting and real estate, which normally do not move in unison. Therefore, even though weights are assigned according to free-float market caps, it could also be argumented that the resulting composition is better distributed than in EWZ.

Correlation

To learn more about the degree of diversification of EWZ, BRF and BRXX, let's analyze their historic volatilities and correlations between them and common benchmarks. We will start with the latter, leaving volatility to a subsequent section where we include the South America Focus model in the analysis.

		Equity				Commodities		Gov. Bonds
	EWZ	S&P 500 (SPY)	Europe (VGK)	Japan (VPL)	China (FXI)	Gold (GLD)	Oil (DBO)	U.S. S/T (SHY)	U.S. L/T (TLT)	Global ex-U.S. (BWX)
EWZ
S&P 500
VGK

Total returns

We will now use these funds as benchmarks to analyse the past performance of the South America Focus portfolio at Covestor. The graph below shows the total return of this portfolio compared with the funds shown before and the combinations that we proposed to study, since its inception on December 3, 2009, as of this writing on May 17, 2010. The data for South America Focus was obtained from its profile page at Covestor, where further details can be found.

As can be seen, the Brazilian markets performed poorly during this period. Nevertheless, South America Focus kept its original value and offered a small profit.

We must keep in mind that the period under analysis is rather short to draw conclusions. However, it is interesting to note that this result is consistent with the advantages that, as we argumented, this model portfolio has to offer.

Quarterly results

To evaluate a portfolio that outperformed its benchmarks, it is of interest to know if the good result occured in one or few bursts, or if it was more or less sustained throughout time, because the first case might be an indication of luck being the reason for it. It is not a conclusive test at all, but it provides some clues that enrich our analysis. Moreover, it is also useful to inspect what happened with the portfolio under different market behaviour, so as to check if the historical performance was consistent with the qualitative arguments presented on our introduction. For that purpose, let's analyze the previous results, but split in three time periods:

1. The inception of the portfolio until the end of the fourth quarter of 2009.
2. The first quarter of 2010.
3. What has passed of the second quarter of 2010 until the day of this writing (May 18).

The first of these graphs shows an outperformance in a period that was rather weak for the Latin-American markets:

During this period, Chilean stocks and a few other picks were successful. Nonetheless, it should not be expected that the portfolio behaves like this often, increasing in value while the markets go down. There was some luck involved in this result. The following graphs show patterns that are, presumably, more normal:

On the first quarter of 2010, as seen here, South America Focus earned almost as much as the best-performing of the funds (PRLAX) even though it was a bad period for Brazilian stocks. We mention this because Brazil should have a greater influence in the portfolio at Covestor than in the Latin-American funds, which include Mexico. Still, the CVIM model outperformed three of the four regional funds.

On the last graph we see the troubles of the last weeks before this writing, mainly the Eurozone problems sparked by Greek-debt concerns, being reflected on the funds' results. South America Focus also retreated, but much less:

The bottom line is that the portfolio performed comparatively well in all of the three non-overlapping periods. We are comparing with six top funds, but in only one period there was one of them outperforming the CVIM model, and it did it by just a very small margin.

Risk comparison

To further the analysis, let's explore risk. In modern portfolio theory, risk is usually associated to price volatility, meaning something like “the average speed” at which the stock's price moves. This measure may be interpreted as the traders' “anxiety” regarding the stock, which is thus related to its perceived risk. It is an imperfect and disputable way of measuring risk, but a useful and widely-accepted one, anyway.

Volatility may be expressed as the standard deviation in price changes during a stated period — the less, the better. Covestor publishes monthly risks statistics for every portfolio on their platform, which includes the standard deviation of daily price changes for the month in question. The following graphs compare those results with the data calculated from the funds' historical prices obtained from Yahoo Finance. Once again, we treat the three quarters separatedly:

This first graph shows all of the six Latin-American funds being more volatile than the US markets (as represented by the S&P 500 index), especially the Brazilian ones. This is expected, because emerging markets are more risky (or, at least, more volatile) than developped economies. Besides, Brazilian funds have additional risk because they lack country diversification. The advantageous average total return of the emerging markets is justified, at least in part and in theory, by this higher risk that its investors have to assume.

On this graph it can also be seen that the portfolio's volatily falls in between the Latin-American and US markets. This fact suggests that, although it is still a more-volatile investment than holding an index fund that tracks the S&P 500, it is not as risky as the Latin-American funds. It is a result that is consistent with the qualitative explanation given on our introduction to South America Focus, where we explained how it has, presumably, better diversification than big funds. The fixed-income portion also plays an important role in decreasing risk.

These patterns are repeated in the other two non-overlapping periods:

This time, the (partial) second quarter does not include May at all, because its risk statistics are not yet published at the time of this writing:

Please remember that past performance is no guarantee of future results, and that the period under analysis is not long enough to draw strong conclusions. As mentioned before, the raw data to prepare the seven graphs was obtained from Covestor (for the results of South America Focus) and from Yahoo Finance (for the fund and S&P 500 index data). To integrate the standard deviations reported by Covestor corresponding to the three months making the first quarter of 2010, we took the root mean square, weighing each month in proportion to its number of days. This page is for informational purposes only, CVIM pays me a fee for each client that subscribes to this model, all the disclaimers on the model's profile page apply, and please take appropriate professional advice in any investment decisions.

Conclusions

Covestor offers a South American portfolio, constituted by stocks and ADRs traded in US exchanges, that provides a vehicle for investing in this fast-developping region with some differences when compared to Latin-American mutual funds and ETF's. These are based, basically, on the possibility to trade more flexibly, given that the assets under management are nowhere near the hundreds of millions typically managed by funds, as it was argumented in our introduction to this model portfolio.

The past history is rather short — just five months and some days more — but the noticeable and sustained outperformance and lower volatility are, to my understanding, signs that the strategy that was explained on the introductory page is working out. To find out more, please visit the rest of our coverage of this portfolio, or its profile page at CVIM.

Thank you for your interest. I wish you the best in your pursuit of financial success!

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