Escape Europe and the U.S. With This Low-Risk, High-Return Market

The current market is a stock-picker’s nightmare. Despite a positive, though slightly uninspiring economic environment in the United States and still fairly strong growth in the emerging world, asset prices are trading on one thing these days… Headline risk out of Europe has caused the markets to ignore improvement in corporate earnings and has driven down risk-adjusted returns. 

When stock markets decouple from the fundamentals in their own markets and trade solely on headline risk, smart investors look for a safe haven until the storm subsides. And I think I’ve found just that…

#-ad_banner-#Traditional safe-haven investments like gold, bonds and the dollar provide for protection, yet offer little possibility of growth. Since the beginning of the year, the iShares Barclays Aggregate Bond Fund (NYSE: AGG) has increased only 2.3%, while the dollar has gained 2.8%. The SPDR Gold Shares (NYSE: GLD) has actually lost 0.6%.

The problem with safe-haven investments is that you have to know when to return to stocks or you will miss out on the rebound in sentiment. This is tough to do and you run the risk of missing out on the best periods for returns. 

What if I told you that there has been an investment which, since beginning of the year, has provided protection as well as growth? Would you think I was crazy if I told you it was also an emerging-market play?

Emerging-market growth with diversified safety
The Global X FTSE Andean 40 (NYSE: AND) is an exchange-traded fund (ETF) that tracks the performance of the 40 largest and most liquid companies in the markets of Chile, Colombia and Peru. The fund started trading in February 2011 when the three countries integrated trading in their equity markets, creating the largest market in Latin America by number of issuers. 

The International Monetary Fund (IMF) is forecasting almost 6.0% average annual growth for these three countries in the next five years, while and gross domestic product per capita has increased by almost 4% a year in the past decade, well above the 0.67% growth in the United States. Sam Zell, billionaire Chairman of Equity International, is investing aggressively in the region and recently told Bloomberg that Colombia would be the, “next star of Latin America.” In the past seven years, the main indexes in these three countries have returned an annualized 18.6% compared with just 1.4% in the S&P 500.

The integrated market may see a bounce when Mexican stocks are listed either this year or next year and could see a rapid increase in capital flows when pension funds are allowed to trade the cross-border shares. This integration will most likely not cause a rebalancing event for the fund, as it is focused on the Andean region rather than strictly on the integrated market. More likely is that the addition of another country in the integrated market increase liquidity and international exposure for the stocks in the Andean region. Since the first integration, the market has allowed companies greater access to capital and lower costs of borrowing, which should increase profitability and growth in the long run.

The evidence for growth in these markets is firmly established. All three countries are actively developing free-trade agreements with the rest of the world. Colombia finalized its controversial agreement with the United States this year, lowering duties on much-needed capital equipment. Peru and Chile have trade agreements with China, while Colombia is in the process of negotiating its own agreement with the country. Colombia and Chile have agreements in force with the European Free Trade Association as well. 

Meanwhile, domestic consumption is growing at an exceptional rate and poverty rates are declining, putting more disposable income toward retail spending. According to World Bank data, economic growth in the region has lifted more than 11 million people out of poverty in the past decade. That’s an additional 12% of the combined population increasing consumer demand. 

What is less well-known — but probably the most appealing part — is the level of safety and diversification available through the fund. 

Since the beginning of the year, the Andean fund has outperformed gold, bonds, emerging markets, the dollar and the S&P 500 on an absolute basis and only underperformed bonds when adjusted for volatility. 

The fund’s correlation with European equities is less than that of the S&P 500, commodities or the broader emerging-market index. This means that while European equities and headline risk are causing asset values to plummet, an investment in the fund should fall less quickly.

The safety comes from a combination of stellar economic performance and diversification across sectors and countries. The fund contains holdings in everything from basic materials (28.4%) and utilities (19.0%), to finance (18.7%), energy (18.7%) and consumer goods (13.1%). A little more than half of the fund is in Chilean equities, while 29% is invested in the Colombian market and 19.9% in the Peruvian market. Some of the fund’s largest holdings include Ecopetrol (NYSE: EC), Latin America’s largest oil company; and Peruvian miner, Compania de Minas Buenaventura (NYSE: BVN). The fund charges an expense ratio of 0.72% and pays a 1.7% dividend yield.

Despite Chile’s reliance on copper as a principal export, the fund holds less than 5% of assets in copper miners and is less correlated with copper prices than the S&P 500. Volatility in the fund is 26.2% in the past year, just slightly more than that of the S&P 500 at 22.9% and gold prices at 21.4% during the same period. 

Risks to Consider: As with all equity investments, the fund is not without its risks. While the fund itself is not highly correlated with commodity prices, the region is a net exporter of energy and metals. An extended decline in commodities will affect the companies in the index as well as overall economic growth. Though current governments are some of the most market-friendly in Latin America, political risk is always a possibility for investments in the region.

Action to Take –> More volatility and downside is expected from global markets, especially those in Europe. While downside risk due to global concerns is probable, the fund should still outperform other regions and individual stocks on a relative basis. Investors could short an international fund like the Vanguard FTSE World ex-U.S. (NYSE: VEU) as a hedge against downside risk while still benefiting from growth in this region with AND.