Renewed Rendezvous: Investors Head to This Region's ETFs

As emerging markets stocks and exchange-traded funds tumbled over the past several years, Latin American equities were a big reason why. With emerging markets being a lagging, hated asset class, disdain among investors for Latin American stocks ran high.

That disdain morphed into love in March, as investors poured into Latin America ETFs as the region's equity markets turned from emerging markets laggards to leaders. For example, the iShares S&P Latin America 40 Index (ETF) (NYSE:ILF) is up about 20 percent year-to-date, a performance that is better than triple the returns offered by the MSCI Emerging Markets Index.

The Tumultuous Relationship Calms, But For How Long?

The $681.5 million ILF is a quasi-regional ETF. In reality, investors embracing this fund are making a bet on Brazilian and Mexican stocks as Latin America's two largest economies combine for over 82 percent of the ETF's weight.

Investors have regained their fondness for Latin American (Latam) shares over March as the region rebounded from lows in the wake of bottoming out commodities prices, improving US relations, and a newly dovish Fed. These factors have combined to see the iShares Latin America 40 ETF, which tracks the 40 largest Latam listed equities, has returned over 20 percent for the month so far. This puts the ETF within reach of its best month on record; a 21 percent jump seen back in March 2007, said Markit in a new research note.

Much of the ebullience surrounding the resurgence of Latin American stocks and ETFs boils down to rebounding commodities prices and currencies. A widely followed benchmark of emerging currencies closed at its highest levels of 2016 Wednesday, underscoring bounces for currencies such as the Brazilian real and Mexican peso.

Investors have also been tactical with their application of Latin America ETFs. While ILF has seen March inflows of $35.6 million, this month's new assets added tally for the iShares MSCI Brazil Index (ETF) (NYSE:EWZ) is nearly 10 times that amount. March inflows to the iShares MSCI Mexico Inv. Mt. Idx. (ETF) (NYSE:EWW) are about $203.6 million, a fair percentage of the Mexico ETF's $1.5 billion in assets under management.

With President Dilma Rousseff on the brink of being booted from office, short sellers of Brazilian stocks, including some held by EWZ, are covering at a feverish pace, forcing short interest in that market to a three-year low, according to Markit data.

Short sellers have also shown no appetite to short Brazilian equities despite their recent surge. The value of Brazilian short positions has fallen by a quarter year to date. The $316 million of short positions taken out against Brazilian equities marks the weakest appetite to short the asset class since 2010, said the research firm.

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