Coutts spots opportunity in Brazilian equities

However, Brazilian equities have been digging a hole in recent months - they are down 9.8 per cent over the past year, making Brazil one of the worst-performing markets in the world. This compares with the FTSE 100 index's 16 per cent rise over the past year.

Gary Dugan, chief investment officer, Asia and Middle East at Coutts, says: "The recent stabilisation of the Brazilian equity market is notable, after a period of marked underperformance. While the minutes from the latest meeting of the Brazilian central bank suggested further increases in interest rates, the market is starting to see an end to the tightening cycle. Indeed, given the split vote on the committee - with some members voting for no rate hike - the market could start to discount an early end to rate rises, particularly with the weakness of global growth and fall in global inflation."

Pointing out the fall in Brazilian equities this year, he says: "Perhaps Brazilian shares have found a more solid foundation on which to build future returns."

Brazil does face some challenges, with Capital Economics recently saying that the country is vulnerable to another crisis or to the eventual end of the ultra-loose monetary policies in developed economies. So it should only represent a small part of your portfolio.

There are 14 exchange traded funds (ETFs) listed on the London Stock Exchange that offer investors passive exposure to Brazil. Most of them track the MSCI Brazil Index, which is designed to measure the performance of the large- and mid-cap segments of the Brazilian market. With 81 constituents, the index covers about 85 per cent of the Brazilian equity universe.

Note that MSCI Brazil ETFs are heavily weighted to sectors such as financials, mining and energy. This means that you could be subject to commodity price volatility.

Emerging market indices are also typically more volatile than developed markets, so while you have the long-term potential to do well with these, as the table with performance of the MSCI Brazil Index shows, over shorter periods you can experience substantial volatility.

Base currency vs trading currency

Currency risk comes into play with Brazil ETFs as the underlying currency of the funds is US dollars (USD). Several providers offer sterling (GBP) share classes, though. This is useful if you don't want to exchange your money for USD.

However, if the base currency of the ETF is USD, but you buy it in GBP, then you won't get the same level of return as if you bought the ETF share in USD. Your level of return will vary according to the exchange rate between GBP and USD. Fluctuations in exchange rates meant that the USD share classes of the Brazil ETFs fared better than the GBP share classes over the past year.

The cheapest Brazil ETF is the HSBC MSCI Brazil ETF (HBRL). It has a GBP share class available and its total expense ratio is 0.60 per cent (its rivals charge 0.65 per cent or more). Launched in July 2010, it is physically backed, holding all 81 companies in the index. It has tracked its index closely, posting a tracking difference of just -1.56 per cent since inception and -0.54 per cent over the year to 31 March 2013. This tracking error compares favourably with rival physical product iShares MSCI Brazil ETF (IBZL) and the synthetically replicated db X-trackers MSCI Brazil Index UCITS ETF (XMBR).

An alternative product is the Lyxor ETF Brazil (RIOL), the only London-listed product to synthetically replicate the Bovespa, an index of more than 60 stocks that are traded on the São Paulo Stock, Mercantile & Futures Exchange. RIOL has a total expense ratio of 0.65 per cent.

The Bovespa index is composed of a theoretical portfolio of the stocks that accounted for 80 per cent of the volume traded in the past 12 months and that were traded at least on 80 per cent of the trading days. On average, the companies making up the Bovespa index represent 70 per cent of the stock value traded on the exchange.

The Bovespa is arguably more risky as it has higher exposure to the resources and oil and gas sectors than the MSCI Brazil index, which has financials as its top sector exposure.

HSBC MSCI Brazil ETF: Top 10 holdings

Annual Performance of MSCI Brazil index vs MSCI Emerging Markets (%)

Source: MSCI. Performance in USD.