EWW: ‘Higher For Longer’ Interest Rates Could Inflict Damage

Today’s analysis provides a systematic opinion on the iShares MSCI Mexico ETF (NYSEARCA:EWW), which is an exchange-traded fund (“ETF”) that tracks the MSCI Mexico IMI 25/50 Index.

The iShares MSCI Mexico ETF presents a few interesting talking points, as Mexico’s “higher for longer” interest rate roadmap might intertwine with the ETF’s high-conviction market-cap weighted structure and result in significant volatility within the next few quarters.

Without further delay, let’s jump into the analysis.

Mexico’s Trend Growth & EWW’s Structure

The iShares MSCI Mexico ETF has tabled price returns of approximately -5% in the last ten years, which isn’t surprising given the nation’s historical growth rates.

Although an emerging market, Mexico’s growth has been underwhelming. And, in our view, its “higher for longer” interest rate outlook will not do its GDP growth any favors. Moreover, as an economy that relies on foreign exchange of goods and services, Mexico might struggle to pick up the pace until consumer confidence returns in the U.S., China, and Europe.

An overview of the iShares MSCI Mexico ETF’s sector exposure suggests that it is overweight on consumer goods, financials, industrials, and basic materials. Although the financial sector can be partitioned away, the others I just mentioned are extremely reliant on a strong export market and low regional input costs.

As things stand, Mexico is struggling to sustain a consistent current account surplus, and its inflation rate of 4.64% implies that local companies might resume their struggle with resilient input costs for the time being. Therefore, I fail to see how sector-based tailwinds will arise anytime soon.

The iShares MSCI Mexico ETF holds 49 securities. Thus, a stock-by-stock analysis would likely be unproductive, which is why I decided to assume a systematic vantage point to assess the vehicle’s style, sector, and economic risks; let’s move into a section on risk premiums to expand the analysis.

Risk Premiums

Risk premiums are often interpreted as expected returns on a given investment, as they illustrate the compensation an investor demands for onboarding its risk. However, an issue with risk premiums is that they don’t always realize; otherwise, we could just pick the highest RPs and become billionaires, right?

Let’s look at Mexico’s risk premiums and figure out whether they might be rewarded or not.

Firstly, compared to the U.S., Mexican stocks are 1.578 times riskier, which essentially stems from the nation’s excess credit risk (0.43%) and excess country risk premium of 0.85%.

If regional macroeconomic variables aligned, I would’ve backed the premiums above to succeed. However, with a severely inverted yield curve, a “higher for longer” interest rate outlook, and soft global production numbers, I think it is unlikely that Mexican stocks will achieve their stated risk premiums for now.

Furthermore, another issue that I identified is that the iShares MSCI Mexico ETF holds a lot of concentration risk as its relative valuation metrics seem priced in while it is also overly exposed to a select few sectors.

Click to enlarge

Source: Portfolio Visualizer.

Income Prospects

The iShares MSCI Mexico ETF’s dividend profile is pretty decent. I say this because of its consistent growth and not just because of the yield. According to Seeking Alpha’s data, the iShares MSCI Mexico ETF has a 10-year dividend CAGR of 9.05%, illustrating that the vehicle could drop your investment’s cost basis considerably if held in the long term.

Despite the ETF’s dividend growth prospects, consider that its dividends are likely taxed in most jurisdictions. Moreover, the aforementioned discussion about Mexico’s slow-ish trend growth might come into play, squandering the ETF’s future dividend growth.

Value-at-Risk & The ETF’s Efficiency

Let’s look at a few of the iShares MSCI Mexico ETF quantitative risk metrics; I added a diagram to the bottom of this sub-section, which provides a full illustration of the following discussion.

The first noteworthy aspect of the iShares MSCI Mexico ETF is its Sharpe Ratio of 0.38 and Sortino Ratio of 0.53, which collectively illustrate that the vehicle provides respectable volatility-adjusted returns. Furthermore, a global stock market correlation coefficient of 0.72 suggests the iShares MSCI Mexico ETF has diversification benefits, which might reduce the unitary risk of your investment portfolio.

Despite the positives, the iShares MSCI Mexico ETF has a few problematic aspects. For instance, it has a negative information ratio stemming from returns below its tracking index and a tracking error. In addition, the ETF has a conditional Value-at-Risk (5%) of 17.80%, implying that it is exceptionally sensitive to economic tail risk.

Final Word

Although the iShares MSCI Mexico ETF’s quantitative risk-return metrics and dividend properties are in respectable territory, the ETF might struggle to realize its expected returns amid a “higher for longer” interest rate environment in Mexico. Moreover, the ETF has substantial concentration risk and seems underwhelmingly priced.