What Is a Brazil ETF?

A Brazil ETF is an exchange-traded fund (ETF) that invests in Brazilian stocks, either through local stock exchanges or via American and global depositary receipts. Brazil ETFs are typically passively managed and track a country index or a widely followed third-party index. 

Key Takeaways

  • A Brazil ETF is an exchange-traded fund that invests in Brazilian stocks, either through local stock exchanges or via American and global depositary receipts.
  • These ETFs are often passively managed, tracking a country index or a widely followed third-party index. 
  • The Brazilian economy is heavily concentrated on materials, energy, and financials.
  • Like most emerging markets, investing in Brazil offers big rewards in exchange for taking on big risk.

Understanding a Brazil ETF

Investors keen on Brazil have two main options. One is to invest directly in companies listed on the São Paolo Stock Exchange, also known as the B3 exchange. The other is to take the offshore route, either through American depository receipts (ADRs), global depository receipts (GDRs), mutual funds or exchange-traded funds (ETFs).

Investing in emerging markets can add an international flavor to a portfolio, as well as the possibility of higher returns. However, stock picking in these countries isn't a strategy suited to most. The Brazilian stock market can be volatile and individual companies difficult to evaluate. Investors hoping to tap into Brazil might be better off spreading their investments in the broader market.

ETFs fit this bill nicely. ETFs are low-cost vehicles that are listed on exchanges and trade throughout the day just like ordinary stock. They aim to replicate the performance of a benchmark index that tracks a broader equity market, specific sector or trend, by mirroring the holdings of their designated index.

1:48

An Introduction To Exchange-Traded Funds (ETFs)

There are a small handful of indexes available for Brazil ETFs to replicate. They range from indexes targeting big international companies to those comprised of smaller, up-and-coming companies whose fate is directly tied to the health of the local economy.

Example of Brazil ETFs

Investors have several Brazil ETFs to choose from. One of the biggest is the iShares MSCI Brazil ETF (EWZ), which has nearly $6 billion in assets. EWZ is listed on the NYSE Arca and tracks the MSCI Brazil 25/50 Index, encompassing the large- and mid-cap segments of the Brazilian market.

The inclusion of 25/50 in its name refers to the capping methodology the index applies. No single stock can make up more than a quarter of the index, and companies that individually constitute more than 5 percent cannot combine to exceed 50 percent of its overall weight. The index's top constituent, accounting for about a 13 percent weighting, is metals and mining company Vale.

Important:

The three most prominent sectors within the Brazilian economy are materials, energy, and financials.

Another popular Brazil ETF is the Van Eck Vectors Brazil Small-Cap ETF (BRF). BRF invests in small-cap companies that derive at least half of their revenue from selling products to Brazilians, making it a play on the local economy.

Benefits of a Brazil ETF

Brazil has a long history of political instability and scandals, so investing in an ETF targeting a broad swath of equities and asset classes may be more prudent than individual stock picking. A Brazil-focused ETF would give investors exposure to a country renowned for its mining, agriculture and manufacturing. The country also has a rapidly growing service sector, which is helping to reduce its dependency on commodities and the buying power of other regions across the globe.

Brazil's quickly developing economy offers the potential for above-average returns, especially when valuations look stretched in more developed economies. In 2019, the MSCI Brazil Index rose 26.3 percent, comfortably outpacing more established markets.

Limitations of a Brazil ETF

Unfortunately, there are many caveats to investing in Brazil. The country has a volatile political history and is dependent on exports, meaning a downturn in other regions of the world can have a devastating impact on Brazil's financial health and stock market. Other emerging market countries, such as China, are among the biggest buyers of Brazil's natural resources.

Diversification can also be an issue. Brazil doesn't excel in all areas, leaving its ETFs generally more overweight in some sectors than others.

There's a dearth of public companies, too, compared with more developed economies. The MSCI Brazil Index, a benchmark tracked by many ETFs, covers 85 percent of Brazilian equities with just 56 securities. That's a far cry from the 500 leading companies that make up the S&P 500 Index.

After a one-year absence, Brazil in 2020 rejoined A.T. Kearney's list of the top 25 countries for foreign direct investment, claiming the No. 22 spot.

Special Considerations

Investors tempted by Brazil can also gain exposure by investing in funds that cover the broader Latin American market or other emerging countries. For example, Brazil accounts for more than 60% of the weighting of the MSCI Emerging Markets Latin America Index, which also includes Mexico, Chile, Peru and Colombia.

Another important factor to consider is currency risk. Many investors underestimate the impact currency fluctuations can have on total returns when investing internationally. If the U.S. dollar rises in value against the Brazilian real, then an unhedged ETF will suffer currency losses that can offset any gains in Brazilian stocks. During periods of dollar strength, it's probably worth considering ETFs that hedge currency risk. This gives investors a return closer to the local-currency returns of a country's major stock indexes.