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Recession Hits South Africa: Avoid this ETF

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South Africa’s economy has been hit by recession for the first time in eight years as it contracted an annualized 0.7% in the first quarter of 2017. This followed a 0.3% contraction in the preceding three months. The South African rand took a beating as it declined more than 1% after the GDP figures were released. Adding to the agony, the unemployment rate rose to its highest level in almost 13 years, that of 27.7% in the first quarter of 2017, up from 26.5% in the previous quarter.

Per the statistics office, all industries except Agriculture and Mining declined in the quarter. The GDP was most negatively impacted by the trade, catering, and accommodation industry.

President Jacob Zuma was already under scrutiny for having illegal ties with the Gupta family and the firing of his finance minister Pravin Gordhan. South Africa’s rating was downgraded to junk by S&P and Fitch owing to the political and economic uncertainty as a result of this action by the President (read: Avoid South Africa ETF Amid Political Uncertainty).

Moreover, the South African Reserve Bank reduced its growth forecast for this year to 1% from its earlier forecast of 1.2% and 1.5% for 2018 from its earlier forecast of 1.7%.

Let us now discuss the most popular South Africa ETF in detail.

iShares MSCI South Africa ETF (EZA - Free Report)

This fund offers investors exposure to the emerging market nation of South Africa by investing in companies based out of the nation.

EZA has AUM of $437.18 million and charges a fee of 64 basis points a year. Consumer Discretionary, Financials, and Consumer Staples are the top three sectors with 34.28%, 24.39%, and 8.70% allocation, respectively (as of June 5, 2017).  Naspers Limited, Steinhoff International Holdings, and Sasol Ltd are the top three holdings of the fund, with 23.98%, 5.17%, and 5.15% exposure, respectively (as of June 5, 2017). EZA has returned 14.02% in the last one year and 14.15% year to date (as of June 6, 2017). It currently has a Zacks ETF Rank #4 (Sell) with a High risk outlook.

We will now compare the performance of EZA with a broader Africa-based ETF, AFK (see all Africa-Middle East Equity ETFs here).

VanEck Vectors Africa Index ETF (AFK - Free Report)

This fund has over 50% allocation to Africa, covering economies such as South Africa, Egypt, Nigeria, Morocco, Kenya, and Mauritius. It also invests in offshore listings of companies incorporated outside Africa but generate at least 50% of their revenues from the continent.

It has AUM of $68.1 million and charges 79 basis points in fees per year. The fund has 31.03% exposure to South Africa. Financials, Materials, and Consumer Discretionary are the top three sectors with 30.8%, 23.6%, and 12.3% exposure, respectively (as of April 30, 2017). Naspers Limited, Commercial International Bank Egypt Sae, and Tullow Oil Plc are the top three holdings of the fund, with 8.49%, 8.00%, and 5.17% exposure, respectively (as of April 30, 2017). The fund has returned 3.66% in the last one year and 11.67% year to date (as of June 6, 2017). As such, AFK currently has a Zacks Rank #3 (Hold) with a Medium risk outlook (read: Central Bank of Egypt Raises Rates: ETFs in Focus).

Below is a chart comparing the year-to-date performance of the two funds.

Source: Yahoo Finance

Bottom Line

Although the South African ETF has outperformed the broader Africa based ETF, the recent rating downgrade for the economy makes the risk associated with it very high. Owing to two consecutive quarters of GDP contraction coupled with the high degree of political turmoil in the region, we believe it is prudent to avoid investing in the region as of now.

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