Mexico ETF a Resilient Player

Now that the U.S. dollar has shown early signs of life after an extended decline, investors may be rethinking their emerging-market strategies. The situation may have them fleeing the riskier fare in exchange for markets with greater ties to the U.S. and solid historical track records.

Last week I introduced my ETF Action newsletter subscribers to the iShares MSCI Mexico Investable Market Index Fund(EWW). So far, this fund has navigated the global downturn better than expected. Not only did EWW hold up longer than other foreign exchange-traded funds in 2008, it has recovered just as quickly.

One reason that Mexican stocks appeared more resilient at the outset of the crisis was diversifying trade. While the U.S. still remains by far Mexico's most important trade partner, Mexico also has steadily increased the amount of exports it sends to other nations in recent years. Mexico's trade with Costa Rica, Chile, Honduras and the European Union has grown rapidly, helped along by a number of trade agreements.

Also, Mexico has been cushioned from the full impact of the U.S. downturn by its extensive access to commodities -- especially oil. Mexico is the third-largest supplier of oil to the U.S. and is the world's 10th-largest crude producer. Rebounding oil prices have supported revenue for the government, which controls the country's oil industry and relies on oil for more than one third of its revenues. Mexico also exports silver, copper, fruits, coffee, cotton and other major commodities -- so as long as commodities prices continue their upward trend, Mexico can insulate itself from the worst effects of the troubled U.S. economy.

EWW invests in a broad range of stocks that mirror the Mexican market, but benchmarking the Mexican bourse results in some dramatic sector weightings and concentrated positions. These include stocks in telecommunications firms such as cell phone provider America Movil(AMOV), basic materials firms such as cement manufacturer Cemex(CX), consumer-oriented firms such as Wal-Mart de Mexico, and financial services firms such as Grupo Financiero Banorte. About one third of the fund's assets are invested in its top three holdings, and recent top holding America Movil alone has long held more than a fifth of the fund's assets. The stock has been a driving force in EWW's 2009 recovery.

America Movil is the largest cell-phone company in Latin America, claiming 70% of Mexico's market share, but it also has expanded into Central and South America, accumulating more than 130 million customers outside of Mexico. The firm is positioned to dominate the Latin American telecommunications sector for years. One institutional buyer is the Bill and Melinda Gates Foundation Trust, which has increased its stake to 1.5 million shares, according to Barron's.

The firm should also benefit from its deal with Wal-Mart(WMT) announced earlier this fall to roll out Straight Talk, a prepaid phone service. AMOV currently earns 5% of its revenue in the U.S. via Tracfone, but the new joint venture could double its current subscriber base of 712,000 in just five years.

Cemex is EWW's third largest holding. Since purchasing competitor Rinker in 2007, CX has become one of the largest cement makers in the world, giving it a lock on huge market shares in a broad array of countries. The stock tanked along with the building bust, acting like dead weight in the portfolio until this year, when CX rebounded from a low of $3.87 in March to a high of $14.20 in September.

Another recent factor supporting EWW has been the strength in the Mexican peso, which is benefiting from global weakness in the dollar. But even if the greenback rebounds, the peso could benefit from local factors, such as fiscal and structural reforms and ongoing economic recovery. Also, with 80% of its exports destined for the U.S., any strength from its neighbor will support the peso.

However, weaker-than-expected performance from the U.S. or Mexican economies would be bad news for EWW. The fund is quite volatile -- its three-year standard deviation through Nov. 30 was 32.19 -- more than 50% greater than that of the U.S. market -- so changes are likely to be abrupt. Yet investors should also be aware that EWW weights its holdings by market capitalization, so it primarily invests in stocks of huge companies.

The fund recently held an average market capitalization of more than $18 billion, and more than 30% of its assets were in giant-cap firms. If large-caps continue to outperform, this will provide additional support to the fund.

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