EIDO ETF: Balanced Risk/Reward Ahead Of A Delayed Pivot

Investors with a longer-term horizon will still find a lot to like with the Indonesian growth story. But selecting the right investment vehicle to ride the near-term shifts is key, and, in this regard, the iShares MSCI Indonesia ETF (NYSEARCA:EIDO) doesn’t screen as attractively here. To be clear, there are push-pull factors – on the one hand, Indonesia’s equity risk premium is on a clear downward path, supported by a strong fiscal position and sustained surplus. Yet, the global interest rate cycle is peaking, and monetary easing is on the horizon, posing downside to net interest margins for banks – a key component of the EIDO portfolio.

While the Indonesian election cycle is also kicking off, fiscal consolidation is likely to take precedence over stimulus, given the current administration’s strong approval rating. Plus, the top two candidates (Prabowo and Ganjar Pranowo) largely represent a continuation of Jokowi’s successful economic policies, and as a result, markets are rightly priced for a benign outcome. So while EIDO should quite easily grow into its current low-teens earnings valuation over time, owning a bank-heavy portfolio isn’t appealing heading into a likely monetary policy pivot.

Fund Overview – A Competitively Priced Indonesian ETF Skewed Toward Financials

The US-listed iShares MSCI Indonesia ETF tracks (pre-expenses) the performance of the market cap-weighted MSCI Indonesia IMI 25/50 Index, a basket of Indonesian large-caps subject to weightage caps (no more than 25% invested in a single issuer). In line with the ETF’s performance, EIDO has seen a modest decline in its net asset base at $502m (down from ~$506m prior). The expense ratio remains competitive at ~0.58%, in line with its closest comparable, the VanEck Indonesia Index ETF (IDX), which charges 0.57% net of fee waivers (0.67% gross).

Despite its weightage caps, EIDO remains heavily concentrated on Indonesian banking, with the allocation further rising to 47.7%, well above the comparable IDX fund’s 29.1%. The rest of the portfolio composition is mostly unchanged, though consumer staples and materials have ceded share at 9.9% and 9.8%, respectively. Communication has gained the highest portfolio share at 9.8%, along with industrials at 5.9%. Given the fund’s increased top-five sector weightage, investors should be wary of the concentration risk from a sector perspective.

The single-stock composition of the 87-stock EIDO portfolio is also largely unchanged, with PT Bank Central Asia Tbk (OTCPK:PBCRF) and PT Bank Rakyat Indonesia Tbk (OTCPK:BKRKY) still the largest holdings at 21.1% and 15.3%, respectively. The ex-financials portfolio continues to be led by telco PT Telkom Indonesia (TLK) at 7.5%, along with Indonesian conglomerate Astra International (OTCPK:PTAIF) at 4.4%. For the most part, EIDO has a similar makeup to IDX, with the key difference being the stricter weightage limits in the latter. The outsized portfolio share of the top five EIDO holdings also stands out relative to comparable Southeast Asian ETFs, so investors looking for diversified exposure to the region should probably look elsewhere.

Fund Performance – Near-Term Rebound Boosts an Otherwise Lackluster Track Record

EIDO has risen by a solid +4.8% this year, outpacing the rest of Southeast Asia, as well as its closest US-listed comparable, IDX (+3.4%). While the long-term performance remains rather unremarkable at an annualized +1.5% (in market price and NAV terms) since its inception in 2010, EIDO has still outperformed its regional iShares peers, many of which have suffered more from the ongoing China slowdown. That said, long-term holders won’t be too happy with the five and ten-year total returns of +2.0% and -1.5%, respectively – hardly adequate compensation for the risks associated with investing in an emerging market.

The consistently strong semi-annual distribution is, however, a nice bonus. Helped by the higher H1 2023 distribution, the EIDO trailing twelve-month yield has now risen to 3.1% (2.8% on a 30-day basis). While EIDO’s yield is lower than IDX and other financials-heavy Southeast Asian portfolios, its defensiveness (equity beta of 0.5 vs. the S&P 500 (SPY)) is a key differentiating factor. Also, the relatively higher earnings growth potential of Indonesian large-caps (+32% in 2023 and +11% in 2024 per consensus estimates) more than justifies the current ~12x P/E.

Blowout Q2 GDP Print Relieves Some Pivot Pressure

Against expectations for some growth malaise in Q2 2023 amid deteriorating China data, Indonesia posted a solid +5.2% YoY GDP growth for the quarter (accelerating from +5.0% in Q1 2023). Domestic demand growth (propelled by the consumption and investment GDP components) was the key driver, offsetting the external drag on Indonesia’s net export contribution (down QoQ). Importantly, a lot of the policies Indonesia has implemented in moving its commodities operation downstream appear to be paying off, better insulating its growth against cyclical price swings. Depending on the impact of El-Nino for the rest of the year, particularly on food inflation, expect more support from domestic consumption as core inflation further eases.

The combination of higher growth and lower inflation bodes well for the broader economy but not so much for a monetary policy pivot. The central bank, Bank Indonesia, has expressed concerns about the stability of its currency as well, so until El Nino clears and the Fed starts sending dovish signals, there isn’t as much urgency to ease for now. From a fiscal perspective, the current administration’s record-high approval rating (see chart below) also gives it optionality with regard to spending; if the 2024 draft budget is anything to go by, fiscal responsibility is poised to take precedence over additional election-related spending. And even if easing does eventually begin (likely sometime toward year-end or early next year), owning a bank-heavy EIDO portfolio into declining rates doesn’t seem ideal, especially with the major banks already priced at a premium.

Balanced Risk/Reward Ahead of a Delayed Pivot

Indonesian equities have been largely flat in recent months, despite a very strong GDP print and easing inflation numbers. The secular growth story remains intact as well, though heading into a potential easing cycle, the bank-heavy EIDO portfolio could see near-term margin pressure. Potential weather disruptions from El Nino will also be worth monitoring for resulting spikes in food inflation and their influence on monetary policy. And beyond an early 2024 election that looks poised to yield a status quo outcome (both leading candidates aren’t deviating from Jokowi’s economic policies), there isn’t a clear re-rating catalyst on the horizon. So even though EIDO is priced at an undemanding low-teens earnings multiple (vs. +32% consensus earnings growth in 2023 and +11% in 2024), the risk/reward seems finely balanced near term.