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Time for South Africa ETFs?

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South Africa is the largest economy in Africa. Last year, the country joined the group of fast growing economies of BRIC, adding the “S” to the acronym to make it BRICS. It is one of only four African countries that have been classified as upper-middle income countries by the World Bank.

South African economy has done well since its transition from Apartheid in 1994. The economy has grown at an average rate of 3.3% while the inflation has remained modest within 3% to 6% range. The country has a well developed financial system and modern infrastructure. (Read: Time to Buy the Singapore ETFs)

South Africa has been endowed with vast natural resources. The country is largest supplier of platinum (~67% of total supply) in the world and also one of the top producers of gold, diamonds and other precious metals like palladium.

South Africa’s main exports are gold, diamonds, platinum and other metals and minerals. The European Union is the largest trading partner (~29% of the exports) while about 14% of the exports go to China. (Read: Africa ETFs-Three Ways To Play (EZA, AFK, EGPT)

The economy grew at 3.1% in 2011, but is expected to slow down to 2.7% in 2012 and then rebound to 3.4% growth in 2013 (per IMF estimates). The central bank has left its benchmark repo rate at 5.5% (a 30-year low) since November 2010, in its efforts to aid recovery.

Among the negatives, the country is among the worst in the world in terms of income inequality, which is further exacerbated by low employment growth in the country. Savings and investment rates also remain low.

The unemployment rate is close to 24% currently; in fact it has remained above 20% for the past 15 years.  About 70% of the country’s youth are unemployed and about 86% of the country’s unemployed are black. For approximately a third of the South Africans, government grants are the only regular income.

All three major rating companies have lowered their outlook for South Africa's debt to negative from stable in the past six months. (Read: Forget Argentina, Buy These Latin America ETFs Instead)

Despite significant reforms in past 10-15 years, the government still had wide control over the nation’s economic activity. Further, market liberalization measures now seem to be on the back burner as the government struggles to deal with issues like high spending and corruption.

While South Africa has been expanding trade with the neighboring African nations (which now account for about 27% of the exports), the growth is currently constrained by the recession in the Eurozone and slowdown in China.

Compared to the size of the economy and external trade, the level of foreign exchange reserves is low (~$48 billion), contributing to increased volatility of the currency, which remains vulnerable to commodity prices and global risk perception. The currency generally moves in positive correlation with gold prices.

The Rand had gained about 30% between 2009 and 2010 but lost almost all gains and fell to its two year low in the second half of last year.

Due to above constraints, the upside for South Africa ETFs may be limited in the near-term. For investors looking to benefit from growth in the emerging markets, better opportunities exist in some Latin American countries like Colombia and Peru.

However Africa is too important a region to be ignored by the investors. Given its vast natural resources and low correlations with most other markets, investments in Africa may continue to be rewarding in the long-run. For investors seeking exposure to Africa, we think South Africa is a better option compared with some frontier market countries, which have high political instability and growth potential comes at the cost of significant risks and high volatility. Below we take a look at the two ETFs (equity and currency) that provide exposure to South Africa.

MSCI South Africa Index Fund (EZA - Free Report)

EZA seeks to track the MSCI South Africa Index, which is a capitalization weighted, float-adjusted index of publicly traded securities in the South African equity market. The index aims to capture 85% of total market capitalization.

The fund currently has $524.3 million in AUM and holds 50 stocks. The fund assigns heaviest weight to the financials securities (27%), followed by materials (20%) and consumer discretionary (16%) stocks. The fund has returned 17.96% to the investors since its inception in February 2003.

EZA charges 59 basis points annually to the investors and has returned 10.73% year-to-date. MTN Group, the African telecom giant is the largest holding (10.6%).

WisdomTree Dreyfus South African Rand Fund

SZR seeks to achieve the returns that reflect the money market rates in South Africa and changes in the value of South African Rand (ZAR). The ETF invests in high quality US money market securities and enters into forward contracts or swaps to gain exposure to South African money market instruments. The fund was launched in June 2008 and has returned 7.69% in since inception. 

Current AUM for the ETF is $4.9 million, expense ratio is 0.45% and it has returned 5.64% year-to-date.


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