Brazil ETF Could Have Even More Room to Grow

The iShares MSCI Brazil Index Fund (EWZ) is trading right around the same level as it was near the beginning of the year.

However, this emerging market fund has an eye-popping long-run track record among ETFs, having appreciated more than 600% over the course of the past five years, and could have even more room to grow.

The fund's top holdings include names such as Petroleo Brasileiro ( PBR), Companhia Vale do Rio Doce ( RIO), Banco Bradesco ( BBD) and Banco Itau Holding Financeria ( ITU).

"It gives investors easy and cost-effective access to 70 of the largest companies in Brazil that represent roughly 85% of total Brazilian markets," says Dina Ting, portfolio manager at Barclays Global Investors.

Even though this ETF has already reeled in major returns for shareholders, one fund manager believes that it is only beginning to unlock its potential.

"Brazil has seen substantial domestic growth that has brought about a rising middle class," says Paul Brigandi, portfolio manager of the Direxion Latin America Bull 2X Fund ( DXZLX). "The country is a huge producer of natural resources. With rising prices, commodity exporters have really benefited."

Brigandi's fund seeks to return shareholders 200% of the daily price performance of the Latin America 40 Index. To achieve this result, his fund uses EWZ as one of its top holdings.

Paul Sutherland, a portfolio manager for the Utopia Funds, is also optimistic toward Brazil's prospects for growth. "I really like what's going on in Brazil," he says, "I think on a long-term basis, they are absolutely going to develop into a first-world country."

The sky may be the limit for Brazil, but its upside potential comes with risks attached.

"Inflation is one of the biggest risks," says Chad Deakins, portfolio manager of the RidgeWorth International Equity Fund ( SCIIX). "The Central Bank of Brazil has been raising interest rates to fight inflation, but with interest rates around 12%, the trend is slowing homeownership in the country."

Provided that the country can get a handle on inflation, Deakins sees Brazil as being among the more appealing, developing economies.

"As long as they can keep inflation under control, it will be an attractive area to invest in going forward," he says. "Brazil is especially attractive relative to other emerging markets."

Brigandi agrees with Deakins on the risk of inflation, and adds that a worldwide market downturn is also a factor to consider.

"Inflation has been the primary obstacle to growth," Brigandi says. "A slowdown in global growth is also a risk, although Brazil is becoming more and more independent of the U.S."

For investors who are looking for an alternative route to using an ETF or mutual fund to invest in Brazil, Sutherland likes multinational corporations that contain heavy exposure to the South American country.

In particular, he likes Royal Dutch Shell ( RDS.A) and Banco Santander ( STD).

Healthy increases in oil and gas prices enabled Shell to overcome challenging conditions in its refining business in the first-quarter and up its quarterly dividend by 11% vs. a year ago. Shares of the integrated oil services company now wield a dividend yield of a little more than 4%.

Banco Santander also has a strong dividend yield at 3.7%. In the first quarter, Santander's Brazil business segment grew its net operating income by 65% over its prior-year results.

One other name that Sutherland likes is Fyffes. The European-based company is one of the largest tropical produce importers and distributors on the continent. The company has its stock listed on exchanges in Dublin and London.

"A lot of their food is produced in Brazil," Sutherland says. "I'm really bullish on agriculture."

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