Ultimate Guide to Brazil ETFs

Brazil has emerged from the global economic crisis with a stronger financial system and a positive outlook, and the iShares MSCI Brazil Index (EWZ) has responded by rising more than 42% year to date.

While much of Brazil's, and EWZ's, success will depend on the continuing recovery of the commodity markets, the country's fundamentals will undoubtedly help support a continued upswing. Brazil's current administration has taken formidable steps to renew the country's financial system, and countries around the globe are eager to invest in this commodities-rich nation.

Exchange-traded funds are an excellent way to gain exposure to Brazil, and the ETF industry has responded to the nation's potential with a number of Brazil-themed products. With a three-month average daily trading volume of more than 21 million shares, EWZ dominates the group, but a recent offering from Van Eck ETF group Market Vectors, the Brazil Small-Cap ETF ( BRF), has already attracted ample investor interest. For sophisticated investors interested in currency trading, Wisdom Tree offers the Dreyfus Brazilian Real Fund ( BZF). The three ETFs mentioned are very different in their construction.

iShares Brazil (EWZ)

EWZ is the largest and most liquid of the Brazil ETFs. On July 10, EWZ hit the nine-year mark since inception, making this the most time-tested fund of the bunch. EWZ tracks the MSCI Brazil Index, and contains 67 Brazilian companies that trade primarily on the Bolsa de Valores de Sao Paulo. EWZ is a market-cap weighted fund, and its portfolio components account for approximately 85% of the Brazilian stock market. Since the fund picks stocks by market cap, large-cap holdings dominate EWZ. Two different Petrobras ( PBR) shares make up the top two holdings of EWZ, comprising 24.18% of the fund.

As of July 10, EWZ was up 42.13% on the year, and the fund imposes a reasonable 0.63% fee. The top three market sectors represented in EWZ's portfolio are materials, energy and financials, with 27.11%, 26.94% and 18.91% allocations, respectively. Interested investors should keep in mind that this fund is top heavy and focuses on the largest companies in Brazil.

Market Vectors Brazil Small-Cap ETF (BRF)

While many of the companies that dominate EWZ's portfolio are based in Brazil, the fund's holdings depend, in large part, on exports and the global economy outside of Brazil. Van Eck introduced the BRF on May 12, 2009, to offer investors access to smaller companies in Brazil that should benefit from an increasing consumer base and a growing middle class. The smaller companies that make up BRF must derive at least half their revenues from selling products to Brazilians.

While BRF may be a "purer" play on Brazil's economy over time, investors must be conscious of the volatility that comes with a portfolio of small-cap firms. The top three sectors represented in the portfolio are consumer discretionary, materials and financials, with 30.9%, 16.5% and 11.3% allocations, respectively. While BRF is a new fund, it has already attracted a three-month average daily trading volume of 101,850. BRF has a 0.73% expense ratio.

WisdomTree Dreyfus Brazilian Real Fund (BZF)

BZF offers investors currency exposure to Brazil, employing a structure that is very different from EWZ and BRF. Instead of holding a portfolio of stocks of Brazilian companies, BZF seeks to achieve returns that reflect money market rates in Brazil available to foreign investors and changes in value of the Brazilian real relative to the dollar. The currency instruments that make up this fund are very short-term, but investors should be mindful that BZF is not a money market fund, and therefore will not have a constant share price.

Since BZF is a different type of fund than EWZ or BRF, investors should not expect returns that compare to the other two funds. As of July 10, BZF was up 13.55% for the year. For the one-month period ending July 10, the fund was down 1.68%. BZF is not as liquid as EWZ or BRF and has a three-month average daily trading volume of just 65,187. The fund has a 0.45% expense ratio.

Brazil is uniquely positioned to emerge from the global economic slowdown stronger than before. The current government has been aggressive in reforming financial policy and placing countercyclical measures into place. Brazil's top companies have been aggressive in reaching out to the broader global market. The recent unsubscribed IPO of Visanet raised approximately $4.2 billion, with 70% of the investors coming from outside Brazil. The New York Stock Exchange currently lists 31 Brazilian ADRs, with a combined market capitalization of approximately $500 billion.

Unless investors clearly understand the risks and rules of currency trading, I would recommend that they choose equity based ETFs like EWZ and BRF to gain access to Brazil's marketplace. EWZ is already an ETF giant, and BRF will likely grow rapidly in the months to come. Whether investors favor the small-cap (BRF) or large-cap (EWZ) approach, Brazil ETFs would be appropriate as a small investment in a well diversified portfolio.

Investors looking for a broader exposure to emerging markets including Brazil can check out iShares MSCI Emerging Markets Index ( EEM), Claymore/BNY BRIC ( EEB), SPDR S&P Emerging Latin America ( GML) and Vanguard Emerging Markets Stock ETF ( VWO).

At the time of publication, Dion had no positions in securities mentioned.

Don Dion is the publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

Dion is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

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