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Chile May Not Need China to Shed Laggard Status

January 8, 2013 12:14 pm
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By the standards of many emerging markets ETFs, the iShares MSCI Chile Investable Market Index Fund (NYSE: ECH) was a laggard in 2012, returning “just” 8.23 percent. That means ECH trailed the iShares MSCI Emerging Markets Index Fund by 520 basis points.

Chile wears the crown as the world’s largest copper-producing nation, a gift and a curse depending on the global economic environment. The copper crown intimately links Chile to China, the world’s largest copper consumer. Perception becomes reality and the reality for investors morphs into the belief that Chile’s economy and its equity markets need China to be firing on all cylinders to make the South American country an attractive investment destination.

That scenario leads Chile to being lumped in with South America’s higher-risk, materials-intensive emerging economies. However, the real reality is that the Chile/China link, while not breaking, may be showing signs of decoupling and that might not be a bad thing for ECH because the ETF and the Chilean can stand their own two feet.

Surprising Correlations
Given the copper conundrum, some investors might expect ECH to move in lockstep with comparable China ETFs. That ignores the fact that the materials sector accounts for less than 15 percent of ECH’s weight and that the sector is just one of five that receives a double-digit allocation within the ETF.

In fact, when measuring ECH against a trio of major China ETFs in 2012, one of two things become clear. Either it China is not moving Chile the way some think it does or it takes a while for ECH to catchup to China ETFs. Either way, the iShares FTSE China 25 Index Fund (NYSE: FXI), the iShares MSCI China Index Fund (NYSE: MCHI) and the SPDR S&P China (NYSE: GXC) all sharply outperformed ECH last year.

Curiously, the correlations are not as intense as some may think. Using GXC as the barometer because it is home to almost 200 more stocks than FXI, providing a broader view of the Chinese economy, it is easy to see this ETF is not intimately correlated to ECH. Over the past year, the correlation between the two is 0.62, down from 0.79 over three years, GDP growth of 5.5 percent last year, a solid number considering China’s commodities demand was questioned for much of the year. Importantly, Chile sported a $1.5 billion trade surplus for December, which was prompted by increased copper demand, Reuters reported.

Domestic demand has been improving, helping the Chilean economy prove somewhat resilient, and the country has the advantage of a $15 billion sovereign wealth fund.

At the domestic level, there is at least one primary risk to Chile’s internal consumption ambitions. Since the government does not provide its employees with the types of grandiose pensions that are so common in the U.S. and Western Europe, Chileans are savers. The country has a mandatory savings plan in place for state workers, leading to one of the highest savings rates in the world.

However, those additional deposits are good for Chilean banks. ECH devotes 18.4 percent of its weight to financial services name and in Chile that is not a bad thing as the country is home to arguably Latin America’s most advanced, regulated, sophisticated and transparent banking sector.

Another potential sticking point for some is ECH’s premium valuation. The MSCI Chile Investable Market Index trades with a forward P/E of 16.2 making it the second most expensive South American Index behind the MSCI Colombia Index.

Brazil, the region’s largest economy, but the true ETF laggard as measured by the iShares MSCI Brazil Index Fund (NYSE: EWZ), trades with a forward P/E of just 10.5 on the index tracked by EWZ. Inexpensive equities have lured some to EWZ in recent weeks, but even a 7.14 percent increase in the past month for that ETF trails ECH by 90 basis points.

For more on Chile, click here.

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