Emerging market exchange traded fund investors should closely monitor their Colombia and Mexico exposure as the two economies join the infamous list of “fragile five” emerging countries.
According to JPMorgan Asset management, Colombia and Mexico are now members of the so-called fragile five group of emerging markets, edging out Brazil and India, reports Steven Johnson for the Financial Times.
The two Latin American countries, along with Turkey, South Africa and Indonesia, are seen as developing countries overdependent on volatile foreign investment flows. The original fragile five were among the worst off during the taper tantrum of 2013 when foreign investors pulled out of the emerging markets.
In the event of another taper tantrum event, Colombia and Mexico may be among the most exposed to a shift to safety.
The two Latin American markets have been under pressure. Year-to-date, the Global X FTSE Colombia 20 ETF (NYSEArca: GXG) plunged 28.3% and the iShares MSCI Colombia Capped ETF (NYSEArca: ICOL) plummeted 28.0%.
Colombia’s market has been retreating in response to the country’s heavy dependence on oil exports. ICOL includes a 14.3% tilt toward the energy sector and GXG holds about 15.5% energy.
Additionally, Colombia’s peso currency has depreciated 36% against the U.S. dollar over the past 12 months. GXG and ICOL do not hedge currency risk, so the depreciating peso has further weighed on returns when converted back to the dollar.
Meanwhile, the iShares MSCI Mexico Capped ETF (NYSEArca: EWW) fell 6.8% so far this year. The SPDR MSCI Mexico Quality Mix ETF (NYSEArca: QMEX), which tracks a more customized basket of Mexico stocks that were selected based on metrics like value, quality and low volatility, dipped 5.0% year-to-date. Meanwhile, the db X-trackers MSCI Mexico Hedged Equity Fund (NYSEArca: DBMX) was down 0.3% so far this year. DBMX and the recently launched iShares Currency Hedged MSCI Mexico (NYSEArca: HEWW) both provide exposure to the Mexico’s market without the added currency risk of a depreciating peso currency. [iShares Unveils Massive Expansion to Currency Hedged Suite]
Mexico is at risk as its reserve coverage ratio, or foreign exchange reserves divided by its funding gap, is just 1.6 years, which is less than the seven years of Russia, another oil exporter. Additionally, Mexico is constrained by its near-zero real interest rate, leaving little room to cut rates if its economy weakens.
“Mexico, a country that many investors consider a safe haven, is now showing up as a high-risk emerging market,” Andres Garcia-Amaya, macro research analyst at JPMAM, told the FT.
JPMorgan also warned that Turkey and South Africa remain the highest risk nations, with Turkey now the most fragile of all due to its reliance on short-term funding. Year-to-date, the iShares MSCI South Africa ETF (NYSEArca: EZA) dropped 6.8% and iShares MSCI Turkey ETF (NYSEArca: TUR) decreased 21.3%.
For more information on the developing economies, visit our emerging markets category.
Max Chen contributed to this article.