ETF.com – Mar 2016

One of the newest ETFs to come to market offers first-of-its-kind access to Latin America’s real estate market. The Tierra XP Latin America Real Estate ETF (LARE) tracks an index of Latin American companies that generate the majority of their revenues from real-estate-related ventures. The fund’s underlying index covers four areas: REITs, developers, property owners/operators and companies that provide services to real estate companies and infrastructure developments.

Jamie Anderson, managing partner at Tierra Funds, discusses how LARE works and why adding this type of strategy to your portfolio makes sense. 

ETF.com: Tell me a little bit about the portfolio. What do investors own with LARE? 

Jamie Anderson: This is the first U.S.-listed ETF product that exclusively focuses on the Latin America real estate asset class. It has 62 components. Approximately 55% of the weights are REIT equities or REIT-comparable equities. The balance are real estate operating companies—residential home developers, service providers, commercial real estate owner operators, etc. We have a fairly robust, diverse set of equities that are represented in this product.

The reference index is the Solactive Latin America Real Estate Index, which we actually created for this product specifically.

One of the goals we set out to achieve was to provide institutional and retail access to the asset class without having to go into illiquid, nontraded, private-equity-type instruments, which, up until this point, was really the only way you were going to get diversified access. Somebody can single-stock-pick with the emergence of listed REITs, especially in Mexico, but they’ll find it’s a challenge to find lower correlation, lower beta and lower volatility without sacrificing yield.

It’s a multifactor approach that takes liquidity, dividend yields and market cap into consideration. It ranks the individual components against the population set and then reranks the entire population. What we end up with is a balance between income and growth.

The index currently has a trailing dividend yield of a little north of 6.5%. I feel really great being able to say the performance year-to-date has been nothing short of phenomenal. Now, we don’t have double-digit returns, but the current net asset value on the product, on a price-return basis, is up 1% year-to-date. The total return is up 2.2%.

And volatility is running roughly comparable to Mexico over the medium term, but it’s about half the volatility of Brazil. To put that into context, Brazil makes up 58% of the weight in the index. So to be running at half the volatility Brazil has shown over the last six-month period—but especially on the year-to-date basis—is a phenomenal advantage for an investor in the product.

ETF.com: From a country exposure, is this really a Brazil/Mexico fund? 

Anderson: It’s about 40% Mexico, 58% Brazil and then we have Chile in there. I will say there’s a very strong likelihood Argentina will be included at some point soon.

ETF.com: If you look at a chart, the iShares MSCI Mexico Capped (EWW | B-97) and the iShares MSCI Brazil Capped (EWZ | B-96) are down 15% and 37%, respectively, over the 12-month period. Why would now be a good time to launch this product? Does it really speak to just how uncorrelated these REITs are to the broad equity market in these countries? 

Anderson: I think that’s multilayered. The big picture is there’s a clear shift in assets going into emerging markets now. We hit a bottom in the broad EM space back in September/October 2015. Since that period, emerging market currencies have either been range-bound or have been actually appreciating. And that’s on the back of a 2 ½-year period where the trade-weighted U.S. dollar appreciated almost 35%.

The weak-EM/strong-U.S.-dollar/preference-for-development market theme is not new. We’re really into our third year here. But investors are sniffing out a bottoming process and they’re allocating capital.

On a more granular LARE-specific basis, yes, real estate has lower correlations to the local benchmarks, but also to the broader benchmarks. For example, between September 2015 through current day, LARE is 49% correlated to the S&P, and it’s 65% correlated to the iShares MSCI Emerging Markets (EEM | B-100), which is a good, broad benchmark.

Brazil equities, meanwhile are 62% correlated to the S&P and 76% correlated to EEM. Mexico is 79% correlated to the S&P, and 88% correlated to EEM. So you can get lower beta, lower vol, but you’re also getting lower correlation.

Lastly, one of the keys to surviving in the EM space is really to buy assets when they’re cheap. And that’s where we’re at now, especially with real estate. I could run through some big-picture P/E and price-to-sale metrics, but the bottom line is that LARE is cheaper than Brazil, substantially cheaper than Mexico and about 15% cheaper than the broad EEM.

Drilling further into the specific opportunities that are represented by LARE in the real estate segment, we think REITs overall—especially in Mexico—represent a tremendous opportunity. They’re growing revenues year-on-year. They’re in expansion mode. They’re acquiring. They’re well capitalized. They have a very strong investor base driven by the local pension market. Contrast that with developed-market REITs—which are in effect either selling assets or taking on debt to pay dividends.

ETF.com: What’s driving this renaissance in REITs in Latin America? Is it a demographic trend?
Anderson:
 It’s demographics, and it’s just the slow march of emerging markets in general. It’s all that stuff. In Mexico, there’s been a shift in consumerism that’s just off the charts. There’s a bona fide middle class and a bona fide upper middle class that wasn’t there in the 1990s, and that benefits real estate as well.

Brazil’s funky because it’s a closed economy. At the end of the day, it’s got capital controls. It’s not an easy place to do business. That said, Brazil is a very strong consumer economy. And when things do start to settle down, the power of the Brazilian consumer is quite strong.

It’s very constructive on the real estate front because on the residential side; you’ve got a very strong cultural preference for real estate as a vehicle for long-term savings. And secondly, you’ve got a very entrenched public subsidy program. So this would be kind of like a combination between Fannie Mae and the FHA.

ETF.com: So LARE is basically an income ETF, a growth ETF and a lower-volatility ETF relative to emerging markets. Where does it fit in a portfolio? 

Anderson: We’re obviously a new product. We have $2.5 million in AUM. If we set that factor aside right now, I would argue this is not just a complementary ETF, but a potential proxy for emerging markets investment—certainly a potential proxy for Latin America exposure. But it’s clearly a potential complement for somebody who owns one of the big products in the region, or the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB | B-58).

I think complementing real estate with a strong income component in EMB is a really nice way to gain that EM exposure and maintain predictable income—and in fact, enhance that predictable income substantially. But it can also keep the volatility down. Adding LARE would also add growth potential, not just income.

ETF.com: What about the currency exposure here? These are locally listed REITs and securities. Should investors worry about the currency factor in this strategy? 

Anderson: No. 1, it would be impractical to try to hedge Brazil, and also Mexico; it would just be prohibitively expensive. But I think, more importantly, we’ve seen the real carnage now. We’re in the third year of this. You wanted to hedge two or three years ago. You don’t necessarily want to hedge now.

We know that a strong dollar is a major theme for the Fed, and for governments around the world. Nobody wants the dollar to get stronger. And frankly, we’re seeing some pretty good indications that global trade—if not already stabilized—is starting to grow again.

The notion that you need to go out and hedge against a decline against the U.S. dollar is probably not a smart money move now. Because what we’ve seen over the last two months is that the strong dollar trade has been exceptionally crowded and it hasn’t been panning out.

ETF.com: What is the biggest risk with this strategy? What could go really south here? 

Anderson: Apart from global macro risk, if the process of uncovering corruption in Brazil somehow started to lose steam, and Dilma’s favorability started to climb dramatically—neither of which I see—that would be a risk.

All I see is indication that this thing is marching forward, and it’s a very constructive process for Brazil. If something changed there, I’d be concerned. Brazil needs to have this political purge. And they’re having it.

On the Mexico front, I would watch for any indication that inflation is starting to creep up consistently above expectations, which we haven’t seen. What we’ve seen is a little bit of CPI overheating, and the Mexican central bank responded very rapidly. But inflation in Mexico, given the strength of the consumer, is something to watch.