Brazil ETFs: What They Are and How They Work

What Is a Brazil ETF?

Brazil exchange-traded funds (ETFs) trade on stock exchanges, much like stocks, and hold assets (such as stocks or bonds) from Brazilian entities. They offer a way for non-Brazilian investors to speculate in Latin America’s largest economy.

Brazil is also an emerging market, and investments in Brazil can further diversify a portfolio.

Understanding the Brazilian Market

With a gross domestic product (GDP) of $1.92 trillion as of 2022, Brazil has the 11th-largest economy in the world, surpassing Australia, South Korea, and Mexico. This reflects Brazil’s vast natural resources, diverse industrial base, and large workforce. It also marks a vast increase in 20 years; its GDP was $509 billion in 2002.

However, Brazil’s per-capita GDP in 2022 was just under $9,000, 101st in the world. This disparity between the overall size of the economy and the wealth of most Brazilians highlights the challenges of uneven economic development within the country.

As a major commodities exporter, Brazil’s economy and financial markets are susceptible to global commodity booms and busts. The strength or weakness of the Brazilian real (BRL) vis-à-vis the U.S. dollar also affects the country’s exporters. Brazil’s high benchmark interest rate, the SELIC rate, also affects equities trading. Brazil’s fiscal reforms, trade pacts, and privatization also affect investor sentiment. Finally, credit downgrades by rating agencies, like Brazil’s loss of investment grade status in 2015, can diminish foreign investment in the country.

The B3 Exchange

The main Brazilian stock exchange, the B3 (for Brasil, Bolsa, and Balcão), is also the largest in Latin America, with a market capitalization of $913,387.25 million as of January 2024. Formed in 2008 from the merger of BM&F Bovespa and Cetip, the B3 is headquartered in São Paulo.

As of January 2024, over 352 companies’ stocks and more than 2,619 companies from all major industries are listed on the B3 and trade electronically on its platforms. In addition to stocks, the exchange also offers trading in options, futures, forwards, and Brazilian depositary receipts, allowing non-Brazilian companies to list shares on the B3 exchange.

The benchmark equity index in Brazil is the Ibovespa, which was first formed in 1968. The index tracks around 80 of the largest and most liquid Brazilian stocks weighted by market cap. Other notable B3 indexes include the Brazil 100 Index, the Brazil 50 Index, the Brazil Broad-Based Index, and various sector-specific indexes.

Choosing the Right Brazil ETF

As of 2024, six Brazil ETFs trade on American exchanges (excluding leveraged and inverse ETFs).

Choosing a suitable Brazil ETF involves reviewing several key criteria: expense ratios, bid-ask spreads, trading volume, dividend yields, and the index or asset class tracked. Each plays a crucial role in determining the suitability of an ETF for your investment goals.

1. Expense ratios: This is the annual rate that the fund charges on its total assets to cover management, administration, and other costs. Expense ratios are important, especially for long-term, buy-and-hold investors. Lower expense ratios are generally more favorable, but they should be considered in the context of the ETF’s overall performance and goals.
2. Bid-ask spread: This is the difference between the highest price a buyer is willing to pay for an ETF share (bid) and the lowest price a seller is willing to accept (ask). It’s a transaction cost that affects the price at which you can buy or sell the ETF. A narrower bid-ask spread is generally better, as it signals more liquidity and lower trading costs.
3. Trading volume: This refers to the number of shares of the ETF traded daily. Higher trading volume typically indicates higher liquidity, making entering and exiting positions easier without greatly affecting the market price.
4. Dividend yield: This is the ratio of a company’s annual dividend compared with its share price. Higher dividend yields can be attractive for income-seeking investors, but it’s important to balance this with the overall investment strategy and growth potential of the ETF.
5. Index/asset class tracked: Understanding the specific index or asset class that the ETF tracks is crucial. This will determine the kind of exposure you’re getting into. Different ETFs may track broad market indexes, specific sectors, or unique asset classes, each with its own risk-return profile.

When evaluating these criteria, consider your investment goals, risk tolerance, and overall market conditions. For example, if you prioritize low costs, then you might focus on ETFs with lower expense ratios. Conversely, if your goal is to achieve more liquidity, then look for ETFs with high trading volumes and narrow bid-ask spreads.

Things to Consider When Investing in Brazil ETFs

When considering an investment in Brazil ETFs, you’ll need to assess several critical factors that can significantly influence your investment’s performance and how it aligns with your financial goals:

1. Large cap vs. small cap vs. broad: The choice of market cap focus will greatly affect your investment. Large-cap ETFs, like the iShares MSCI Brazil Index Fund (EWZ), mainly consist of mega- and large-cap stocks and provide broad exposure to the Brazilian economy. Small-cap ETFs, such as the MSCI Brazil Small Cap Index Fund (EWZS) or the Market Vectors Brazil Small Cap Index ETF (BRF), focus on smaller companies and offer a more direct play on local Brazilian market dynamics. Broad-based ETFs cover all company sizes.
2. State-owned companies: Many Brazilian companies have significant government ownership. This can influence company decisions in ways that may not always align with shareholder interests. Large-cap ETFs tend to have higher allocations to state-owned companies, while small-cap ETFs usually give less weight to such stocks.
3. Sector biases: International ETFs often prefer specific sectors. For Brazil ETFs, significant allocations are typically made to materials, financials, and energy sectors, which can form a substantial part of the portfolio. Conversely, these ETFs might underallocate funds in industries like healthcare and consumer discretionary, which could be a concern given the expected growth in consumer spending because of the rising middle class in Brazil.
4. Currency exposure: Brazil ETFs likely have exposure to the Brazilian real, meaning that the ETF’s performance can be affected by currency fluctuations. If the Brazilian real strengthens against the U.S. dollar, it could positively affect the returns of Brazil ETFs for U.S.-based investors.
5. Special tax considerations: Brazil has unique tax considerations that can affect the returns for U.S.-based investors. Although a 2% tax on foreign equity investors was eliminated, the potential for future taxes on foreign investments exists and could affect Brazil ETFs. Since the beginning of 2023, the Brazilian government has been exploring ways to increase tax revenues to support its social agenda. However, these measures mainly affect Brazilian residents who hold foreign investments, with little to no impact on non-Brazilian holders of Brazil ETFs.
6. Government instability: Political scandals, corruption investigations, and impeachment proceedings have all been part of the background to volatile policy shifts in Brazil in recent years. This brings uncertainty and impacts markets. For example, Brazil has faced major swings in inflation over the past two decades, decreasing from a height of over 14% in 2003 to between 3% and 9% for the next 15 years or so, and reaching over 9% in 2022.
7. Liquidity risk: Brazil’s equities tend to be less liquid than developed markets. This can increase trading costs for large orders. It can also vary among Brazil ETFs, depending on their underlying holdings.
8. Volatility: Brazil’s stock market has experienced extreme booms and busts along with its economy, compared with more developed markets.

Ways to Reduce Risk Before Investing in Brazil

Investing in Brazil does carry risks, but it can be done safely to enhance a diversified portfolio by following prudent investment principles:

• Diversify across sectors, market caps, stocks, and geographic regions to avoid overexposure to any part of the Brazilian market.
• Limit your allocation to Brazil. Many advisors suggest total emerging markets exposure of 5% to 10% of a portfolio.
• Choose large, more established Brazil ETFs with ample liquidity and transparent holdings.
• Balance Brazilian equities with stable assets like bonds, cash, and developed market stocks.
• Hedge currency exposure through ETFs that neutralize the effects of a weakening Brazilian real.

The Bottom Line

Brazil ETFs offer a good option for American investors who want geographic diversification to the Brazilian markets, with their unique dynamics and opportunities. However, understanding the nuances of the Brazilian market, recognizing the risks involved, and aligning them with your investment strategy is crucial.

The comments, opinions, and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or adopt any investment strategy. While we believe the information provided herein is reliable, we do not warrant its accuracy or completeness. The views and strategies described in our content may not be suitable for all investors. Because market and economic conditions are subject to rapid change, all comments, opinions, and analyses contained within our content are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment, or strategy.