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What's in Store for Mexico ETF as Inflation Continues to Rise?

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The Bank of Mexico or Banxico has embarked on an aggressive strategy to hike interest rates to combat inflation. Banxico raised its interest rates for the fifth straight time on Thursday, March 30, 2017. The central bank board decided to raise rates by 25 basis points to 6.5%. It led to the peso closing at 18.67/$ on Thursday, March 30, 2017.

This decision comes as inflation rose to the highest level of 5.29% in early March since the 2009 recession, far above the 3% inflation target. Inflation soared as uncertainty over the Nafta renegotiation weighed on the currency and the country decided to roll back gasoline subsidies.

The Peso had fallen to as low as 22/$ in January. Trump’s unfriendly policies toward Mexico have weighed on the currency since the day he was elected. His stance on bringing back factory jobs back to America has proved to be an outright disaster for Mexico’s currency.

The central bank said its aggressive stance on interest rates is due to a desire to avoid a contagion in price formation in the economy and to fight ever-increasing inflation. The bank’s stance also seems to be protecting investment capital by keeping the rates attractive.

The primary issue is that inflation is expected to rise again and hence more rate hikes are expected. This is not sustainable. Peso is used as a cross hedge tool but owing to the bank’s policy its attractiveness may reduce.
 The outlook for Mexico remains negative, as per S&P and Moody’s ratings, owing to a great deal of uncertainty in the region.

iShares MSCI Mexico Capped ETF (EWW - Free Report)

This fund offers exposure to companies based in the emerging market nation of Mexico.

It has AUM of $1.54 billion and charges a fee of 48 basis points a year. Consumer Staples, Financials, and Materials are the top three sectors of this fund with 23.96%, 20.93%, and 17.3% allocation, respectively. It bears significant concentration risk with 58.3% allocated to the top 10 holdings. The fund returned 16.37% in the year-to-date time frame and lost 3.38% in the past one year (as of March 31, 2017). The fund’s net outflows amounted to $548.14 million in the year-to-date time frame. EWW currently has a Zacks ETF Rank #4 (Sell) with a Medium Risk outlook.

We will now compare the performance of EWW to a broader Emerging Market ETF, EEM.

iShares MSCI Emerging Markets ETF (EEM - Free Report)

This fund is the most popular in the emerging market equity space with $29.65 billion in AUM.
China, South Korea, and Taiwan constitute more than 53% of the fund’s exposure. Around 22% of fund assets are allocated to its top 10 holdings. It charges 67 basis points in fees per year. Financials, Information Technology and Consumer Discretionary are the top three sectors with almost 60% of fund assets allocated to them. The fund returned 16.37% in the year-to-date time frame and 16.75% in the past one year (as of March 31, 2017). The fund’s net inflows amounted to $619.13 million in the year-to-date time frame. As such, EEM currently has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: Why Emerging Market ETFs Are Surging This Year)

Source: Yahoo Finance

To Conclude

We note that the broader Emerging Market ETF EEM significantly outperformed the Mexico ETF in the year-to-date time frame. The recent positive performance of EWW can be attributed to the constant rate hikes to combat inflation by Banxico. Though investors are looking at emerging market investments now due to uncertainty regarding President Trump’s protectionist agenda implementation, there is still high risk associated with Mexico. Therefore, diversified exposure to emerging markets is advised to reduce the risks of drawdown from one particular investment and it is prudent to avoid the Mexico ETF (read: Why Did International ETFs Outperform in March?).

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