Brazil’s Lagging Infrastructure; Time To Buy BRXX?

by on August 18, 2010 | ETFs Mentioned:

Thanks to weak growth prospects, sky-high unemployment, and massive debt burdens in much of the developed world, many investors have begun to shed their “home country bias” by turning to emerging markets as a primary driver of growth within their portfolios. But while growth prospects in the BRIC and smaller emerging markets are significantly brighter than the U.S. and western Europe, the developing economies of the world face their own obstacles. Brazil, for example, has been a popular investment destination in recent years; the country’s immense natural resources and strengthening trade relationship with Chine have boosted equity markets over the last 18 months. But Brazil has fallen far behind even its emerging market counterparts in terms of infrastructure investment, an oversight that could leave the surging country in a perilous position.

Forty years ago, Brazil invested close to 5.5% of its GDP in infrastructure; today that number is down to just over 2%. While it represents a total dollar amount that is much higher, this measly expenditure is not enough for the country to maintain and improve the infrastructure for a booming middle-class population that is far more mobile (and wealthier) than it was in the early 1970′s. In fact, Morgan Stanley believes that the country needs to invest close to 4% of its GDP in infrastructure in order to achieve 5% annual growth for this decade. The investment bank is also now forecasting that Brazil will spend close to $225 billion on infrastructure in the next three years, an amount on par with the spending expected in India–a country with over four times as many people [see India Infrastructure ETF Hits The Market].

The lack of investment has already begun to have a noticeable impact on the Brazilian economy; some analysts believe that the shortage of developed roads, utilities, and ports could limit investment in the country as companies and investors look to set up shop in markets more capable of transporting goods and people efficiently. In a recent survey at the 2009/2010 World Economic Forum in Geneva, Brazil scored 3.4 for its infrastructure quality (on a scale from 1 to 7), below the world average of 4.1. “The quality of Brazil’s infrastructure ranks among the worst in the world,” the report states, “in spite of investments launched four years ago.” Emerging markets scoring better than Brazil included Mexico, China, Turkey, South Africa, and Chile. Brazil’s railroad quality score of 1.8 points ranked ahead of only Colombia in the survey.

Unfortunately for the export industry, these dismal performances represent missed opportunities; an inability to efficiently transport goods from within the country to coastal ports (and then from ports to ultimate destination) means that Brazil’s crumbling infrastructure is exacting an economic toll. “We spent decades without making investments and that led to growing problems now showing in the current state of our infrastructure” said LCA Consultores chief economist Braulio Borges, who authored the study [also read Beyond EWZ: Five Other Latin America ETF Options].

Hope For The Future?

Luckily for many investors who are concerned about the sorry state of Brazilian infrastructure, two of the most important sporting events in the world, the World Cup and the Olympics, will both be held in the country this decade. These events could help to spur the country to action as the government looks to capitalize on its time in the international spotlight. Outgoing president Luiz Inacio Lula da Silva launched a nearly $900 billion infrastructure plan earlier this year, focusing on improving transportation, power supplies, and port access [read BRXX Surges On Infrastructure Plan].

Furthermore, China is quickly accelerating its investment in the country in order to help make transportation of commodities and other exports easier in the South American nation. This boost should greatly help Brazil develop infrastructure while taking much of the spending burden off of their shoulders. A recent article in Reuters highlighted some of the ways that China is looking to get more involved in Brazilian infrastructure plans:

State Grid, China’s biggest electrical utility, is paying $1.7 billion for seven Brazilian electricity transmission companies. Construction machinery maker Sany Heavy Industry is building a $200 million plant as Brazil ramps up infrastructure plans ahead of the 2014 soccer World Cup and 2016 Olympics. Chinese firms are among the front-runners to build a $19 billion “bullet” train line between Sao Paulo and Rio de Janeiro.

ETF Way To Play

For ETF investors, there’s a fund offering pure play on Brazilian infrastructure sector: the Brazil Infrastructure Index Fund (BRXX) from EG Shares. This ETF tracks the INDXX Brazil Infrastructure Index, a free-float capitalization weighted benchmark comprised of 30 companies representative of Brazil’s infrastructure sectors. The fund is heavy in the utilities, industrial materials and telecommunication sectors, which combine to make up close to three-fourths of total assets.

Unlike many emerging markets ETFs, BRXX doesn’t focus exclusively on mega cap stocks. About half of BRXX’s assets go to mid cap securities, with about 35% in large caps. Since the fund’s inception in late February, BRXX has climbed by about 7%, and BRXX is up more than 8% over the last month.

If Brazil wants to be recognized as the best-of-the-BRIC going forward, it will need to heavily ratchet up infrastructure investment in order to remain competitive, a development that could be good news for investors in BRXX over the long-term [also read Brazil ETFs: Best Of The BRIC].

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Disclosure: No positions at time of writing.