Evaluating The Resurgence of Colombia ETFs
Colombian stocks closed slightly lower with the Colombian Stock Exchange losing about half a percent. Many U.S. investors probably did not notice and nor did they notice the seven-day winning streak that preceded Monday's loss.
There was a time when ETFs with exposure to South America's second-largest economy, namely the Global X FTSE Colombia 20 ETF (NYSE: GXG), were among the best options for investors seeking exposure to Latin America. From 2010-2012, GXG outperformed the iShares MSCI Brazil ETF (NYSE: EWZ) and the iShares MSCI Chile ETF (NYSE: ECH).
Novices framed the rise of Colombian equities as the result of the country no longer being viewed by international investors as solely an exporter of cocaine. By beating that dead horse, those pundits overlooked critical elements of the Colombian investment thesis such as rising oil production that has made the country South America's third-largest crude producer.
Additionally, continuing to talk about cocaine obfuscated the fact that Colombia has a vibrant banking system and that Moody's Investors Service and Standard & Poor's both lifted Colombia's credit rating into investment-grade territory in 2011.
Fast-forward to 2013 and, for most of this year, the Colombian investment thesis and GXG have held little allure to investors. The ETF is down 11.2 percent year-to-date. Foreign direct investment in the country plunged 6.2 percent to $8.75 billion in the January through June period, from the $9.33 billion it received in the same period last year, according to Reuters.
Inflows to the energy and mining sectors, critical elements of the Colombian economy, dipped 5.5 percent. Those two sectors combine for nearly 38 percent of GXG's weight. Colombia's status as a major producer of gold and copper has not served GXG and the rival Market Vectors Colombia ETF (NYSE: COLX) well this year, but Ecopetrol (NYSE: EC) has been a real drag on Colombian stocks.
Ecopetrol, Colombia's state-run oil company, was once a shining star among state-controlled energy companies. This year, however, the stock is part of an infamous group of state-run, emerging markets energy firms whose shares are hampering scores of ETFs while being trounced by their U.S. rivals. Shares of Ecopetrol, 15.3 percent of GXG's weight, are down 25.5 percent year-to-date, a loss that is barely better than the 29 percent tumble seen by Brazil's Petrobras (NYSE: PBR).
While investors may have noticed that select emerging markets ETFs have recently been on the mend, they may not have noticed that Colombia funds are leading the charge. The rub here is that taking part in upside for Colombian equities means using an ETF such as GXG or the newly minted iShares MSCI Colombia Capped ETF (NYSE: ICOL).
Only one quasi-diversified emerging markets ETF, the Global X FTSE Andean 40 ETF (NYSE: AND), features noteworthy exposure to Colombia. Larger, more familiar, multi-country emerging markets ETFs feature scant exposure to Colombian shares.
In the past month, GXG has surged 8.8 percent. The iShares MSCI Colombia Capped ETF is barely more than a month old and when that funded debuted, it looked as though it it was going to be a case of bad timing. The opposite has been true as ICOL already has $12.8 million in assets under management and has soared 9.5 percent since its debut.
The driver of the rally in Colombia ETFs has been, not surprisingly, Ecopetrol. As the U.S. Oil Fund (NYSE: USO) has jumped 15.7 percent in the past month, shares of Ecopetrol are up 11.6 percent. Over that time, the Colombian oil giant has left Petrobras, Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX) in the dust. The new ICOL is even more levered to the Ecopetrol trade than GXG. The iShares offering devotes almost 18.4 percent of its weight to that stock and 33.4 percent of its weight to the energy sector, according to issuer data.
Cheap, Of Course
One of the most frequently heard clarion calls about emerging markets these days is that they are cheap on a valuation basis. The same can be said of Colombian stocks. GXG has a P/E of 15 and a price-to-book ratio of 1.34, implying the ETF trades at a discount relative to the comparable Brazil and Mexico ETFs as well as the broader emerging markets universe.
However, the real catalyst for the rise in Colombian stocks and the aforementioned ETFs is more attributable to the credit markets. Earlier this month, Moody's boosted the country's debt rating outlook to positive, citing a dwindling budget deficit that will help reduce debt levels. Moody's forecasts Colombia's debt will fall to the equivalent of 32 percent of gross domestic product this year from 34.5 percent in 2009, according to Bloomberg.
Yields on Colombian bonds sank after Finance Minister Mauricio Cardenas said the government will delay action that encourages pension funds there to invest more capital overseas. The yield on Colombian 10-year sovereign debt is 6.67 percent, down from 7.04 percent on July 8. Since July, ICOL is up 8.7 percent.
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