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Why You Should Avoid the South Africa ETF

EZA AFK

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The global financial turmoil severely tested the mettle of many a developing economy. While many proved their resilience, others were stretched considerably to survive the crisis. In this context, volatility in the financial and commodity markets had hit the South African market pretty hard.

Labor unrest and strikes in the mining and transportation industry of South Africa continue to hamper its growth prospects and its currency, the rand. Resource-rich South Africa is arguably the world’s largest producer of precious metals and likewise its currency is regarded as a commodity currency exhibiting high volatility (Time to Exit South Africa ETF?).

Due to a protracted strike in the mining industry, the country’s economic output and its growth, which has already been impacted by the euro-zone crisis, come into the limelight again. The mining industry makes up 60% of the country’s exports which implies that the country’s growth is highly dependent on the segment.

Recent Trends in the Mining Sector

Work stoppages in the mining sector resulted in huge production losses. This led to a decrease in mining revenue by R15 billion thereby hampering the overall growth of the economy.

The curtailed output in the mining industry also leads to a higher trade deficit which again puts a question on the country’s currency prospects. In fact, South Africa’s current account deficit is expected to inflate to 6.4% in 2013.

Unemployment

Apart from this, a high unemployment rate in the country also remains a major concern as it is approaching the rate of 25%. About 70% of the country’s youth are unemployed as well, suggesting that an entire generation of South Africans are being left out of the economy.

For approximately a third of the South Africans, government grants are their only regular income. Per central bank’s estimates, a growth rate above 7% is needed to make any significant dent in the unemployment rate.

According to the New Growth Plan, which was launched in November 2010, the South African government aims to streamline the economy in order to have a more sustainable growth while creating five million new jobs by 2020 (Time to Invest in Platinum ETFs?).

It is not just the higher unemployment level which is hampering the growth prospects of the economy; rising inflation level also remains a matter of concern. Inflation rose to a 10-month high of 5.9% in February.  Additionally, the government’s attempt to grow the economy’s middle class has failed and basic education appears to be weak.

Also, high production cost and an inflexible labour market have repulsed investors from the South African market. In fact, manufacturing growth appears to be largely hampered by low levels of investment.

In such a scenario, iShares MSCI South Africa ETF (EZA - ETF report) turned out be one of the worst performing country ETFs to start the year. The fund has delivered a negative return of 9.56% year to date, as the fund continues to be affected by troubles surrounding the country (Three Country ETFs Struggling in 2013).

EZA in Focus

EZA is one of the main sources to play the South African economy and provides exposure to 51 securities. The fund manages an asset base of $506 million and trades at volume levels of more than 200,000 shares a day.

At 12.82%, EZA allocates a hefty proportion to the Mining sector occupying the fourth position, after Financials (28.4%), Consumer Discretionary (18.8%) and Telecommunication (13.46%).

So it can be said EZA’s heavy exposure to mining companies may have impacted its performance to a large extent. The recent turbulence in the yellow metal and mining companies seemed to have a negative impact on the ETF (Top Mining ETFs in Focus).

The fund has also not been able to do much in minimizing stock-specific risk either, as nearly 55% of the asset base goes towards the top ten holdings. Among individual holdings, MTN Group, Naspers and Sasol occupy the top three positions in the fund with asset allocation of 11.81%, 10.13% and 9.02%, respectively. The fund charges investors 60 basis points in fees annually.

Clearly, given the many problems afflicting the nation, South Africa should be avoided and the focus should be on other markets instead. For this reason, we have a Zacks ETF Rank #5 (Strong Sell) on EZA, suggesting that we believe underperformnace is in the cards for this fund in the near term as well.

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