Friday, 19 May 2017

Brazil - An Emerging opportunity for long run value

Brazil sold off yesterday in a big way. 

The MSCI was down ~15% due to a combination of BRL taking the greatest dive since 2003 and the Bovespa selling off by around the same amount. Now prior to that point Brazil was looking fairly cheap against a number of more 'promising' emerging markets like India. So now to my mind it looks really cheap.

Why the sell off? Corruption. Brazil is so corrupt the current corruption scandal threatening Temer is actually related to the previous corruption scandals and alleged payments made to silence some other figures. But everybody knows Brazil is corrupt. It is astonishing how hard the market was hit yesterday in Brazil vs the very minor waves made in the US. The US is ultimately threatened by a much greater kind of corruption which is sheer idiocy - something that the US market does not widely price in.

What we also know is that investors are terrible at pricing politics. The Trump win was a classic example -  a three hour selloff followed by a major rally which was quite unexpected:

ABC News

Or Brexit - where stocks slumped for around a week before regaining new highs later in the year (albeit not in GBP terms). 

Looking regionally the victory of Lula in 2002 saw one massive selloff in all things Brazil right before the best decade the country had experienced for a generation. Another regional example would be the 2011 Peruvian election where Humala the leftist candidate won, the market sold off in panic, and then he did approximately nothing and things recovered.

So from a long term view I see the current price of the Brazilian market as an attractive entry point. I may well eat my words in the coming days but to my mind corruption in Brazil is par for the course. 

So how to invest in Brazilian equities?

Well I have bought the Ishares MSCI Brazil ETF (LON:IBZL) on the basis that:

  • (a) This current dip is a limited time opportunity and I dont have the resources to select individual stocks
  • (b) I do not have local market access so buying ADRs leaves me with a relatively narrow selection of options (although many large caps like Petrobras, Vale and Itau are there).
  • (c) Buying ADRs increases my costs due to FX transactions which are expensive on a retail brokerage platform whereas the ETF is priced in GBP on the UK exchange and so is cheaper to purchase.
  • (d) I get built in diversification benefit which aides point (a) because I haven't done enough research bottom up to pick stocks.
  • (e) The TER on the ETF is 74bps which is not too bad for an emerging market ETF.

So what do we get in this ETF? Well the top holdings are the major banks, Petrobras, Vale and assorted financials. The key sectors of the market are 35% Financials, 15.5% consumer staples, 12.5% materials and 12.2% energy. 

MSCI Brazilian Market by Sector (Date: IShares/MSCI)

So its a generally domestically exposed stock market in a country which derives a lot of its value and foreign exchange from exports. Not unlike Nigeria actually except more developed, with more industrial base and a more diversified basket of exports; Iron ore, Oil, Soya, Sugar Cane, Poultry etc:

By Celinaqi - Own work, CC BY-SA 4.0,

Now if we couple this broad and liquid stock market with a diversified economy and then throw in some pretty decent domestic demographics we have a fairly good top down argument for a long term investment in Brazil.

Population - Brazil

Looking at the market itself after the selloff it trades around 12x P/E which is low even by most EM standards (however note the heavy composition of Financials and Commodities which do trade at lower multiples).  The CAPE for Brazil now must be around 9x P/E which is also cheap and it ranked in the best quartile of international markets even before this 15% drop in price. Ok Russia is cheaper but it has poor demographics, a more 'involved' global risk profile and a market heavily weighted to energy (thus giving me little diversification benefit.) Other EM markets at this price either have narrow markets (Taiwan - Tech) or even worse levels of corruption and debt mis-allocation i.e China (They just hide it better).

The addition of the ETF also adds some further diversification benefit to the portfolio bringing in more commodity exposure and EM domestic growth dynamics and taking risk away from developed markets. I am still Latam heavy but this is the area I used to work in and so I know it better than Asian markets or other EM. That is likely an emotional bias but it also helps if you know what you are looking at especially in EM where one is not comparing apples to apples between countries.

To be honest I just feel Brazil is cheap and I get that excited 'value' feeling about the market. There is always time later for more deep analysis and additions to the portfolio or I can sell the ETF and exchange it for attractive Brazilian stock opportunities down the line. Latam is my bag experientially so I am happy to take some of the SIPP funds and invest a modest proportion of the portfolio in IBZL. If this drops further in the next few days I will top up the position I bought into this morning. 

Disclaimer: I have an interest in IBZL as mentioned in this article at present. These are opinions only, not investment advice. If in doubt read my disclaimer.

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