BRF VanEck Brazil Small Cap ETF

Despite some periods of high volatility and uncertainty, many emerging market ETFs have been strong performers in 2012. Some of the top country ETFs, including those that target nations like China, India and Mexico, have all added double digits on the year, easily outpacing the S&P 500 and broad emerging market benchmarks as well.

Yet there is one big exception from this list, the South American giant of Brazil. Its most popular ETF, the iShares MSCI Brazil Index Fund (EWZ), has had a rough go in 2012, losing over 5% at time of writing, while the product is also down a similar level when looking at three and five year metrics (read Do Country ETFs Really Provide Diversification?).

This is pretty surprising as it suggests that Brazil, a nation that many believe could become a global economic force in the 21^st century, has lagged significantly its competitors in the YTD time frame. Given that commodity prices were relatively strong in the middle part of the year, one has to wonder if EWZ can come back, or if flat returns should be the new normal for this product.

After all, recent reports suggest that Brazilian growth rates will be the lowest among the major BRICS nations for 2012 with an increase that is roughly half the next closest member, South Africa. Meanwhile interest rate cuts have had little impact on spurring growth, despite the fact that the benchmark Selic rate has dropped 525 basis points in 10 straight Central Bank slashes.

This is somewhat troubling as further cuts may be necessary, but these will likely increase inflationary concerns, while the Brazilian currency hasn’t exactly been strong either. This movement lower by the real has acted as a double whammy on foreign investors, further hampering dollar-denominated returns in 2012, and casting a big shadow over 2013 growth prospects (read Brazil ETFs: More Trouble on the Horizon?). 

Clearly, this trend has left EWZ at the bottom of the emerging market pile as few investors are bullish on the country for the time being. However, despite the pessimism, there are actually some corners of the Brazilian ETF world that are holding up surprisingly well and could be better investment targets at this time.

These potentially better investment plays come to us in the form of mid-cap and small cap Brazilian ETFs, as well as the consumer targeted fund. These products have been performing far better than EWZ this year, and if anything, have been outperforming major emerging market ETFs so far in 2012 as well.

At least part of this outperformance has to be due to the far more spread out nature—and the sector choices-- of these ETFs when compared to EWZ. The iShares large cap focused fund has over 15% of its assets in Petrobras and another 10% in Vale, suggesting a pretty heavy concentration in these two struggling giants.

The same situation isn’t happening in the small cap and mid cap focused funds targeting Brazil, as these ETFs like BRAZ for mid cap exposure, BRF and EWZS for small cap holdings, and BRAQ as a consumer play, have all done much better on a year-to-date basis. In fact, not only do these do a better job of diversifying away company specific risk, but they all have a much bigger allocation to consumer segments and industrials than their massive EWZ counterpart (see Forget Petrobras with These Brazil ETFs).

This has led to huge outperformance for the group of BRAZ, BRF, EWZS, and BRAQ as all four have beaten out EWZ by at least 1,000 basis points so far this year. Furthermore, the two small cap products have both added more than 12% this year, while the consumer fund has gained more than 28%, suggesting that this corner has been the real place to be in Brazil in 2012.

So while some investors may be beginning to panic over Brazil, it probably isn’t warranted. Yes, the country does have some significant issues plaguing its economy, but there are still some solid sectors that are humming along, even if they aren’t being represented heavily in EWZ.

These segments include the consumer and the broad small cap space as these firms are closer to the growing consumer growth story in Brazil and thus are seeing more of the benefits than what firms like Vale and Petrobras are experiencing. Due to this, it could be time for investors who are deep into EWZ to consider making a different play on the Brazilian economy (see Access the $30 trillion Consumer Market with These ETFs).

The consumer and smaller securities have clearly developed a leadership role for Brazil at this time, even during this low growth environment for the nation. They have proven to be something of a safe haven and thus may be a better pick for investors who want to tap into the real Brazilian growth story, instead of targeting the nation with the multi-national firms that are clearly struggling and falling behind their pint sized and consumer focused peers.

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GLBL-X BRZL CON (BRAQ): ETF Research Reports
 
MKT VEC-BRZL SC (BRF): ETF Research Reports
 
ISHARS-BRAZIL (EWZ): ETF Research Reports
 
ISHARS-MS BR SC (EWZS): ETF Research Reports
 
PETROBRAS-ADR C (PBR): Free Stock Analysis Report
 
VALE SA (VALE): Free Stock Analysis Report
 
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