What is FLN? (Pros, Cons, and Strategies)

Investors aiming to diversify their portfolios and gain exposure to emerging markets often look towards specialized ETFs. The First Trust Latin America AlphaDEX Fund (FLN) is one of those niche funds designed for this purpose. In today's post, we'll dive into what FLN is, along with its advantages and disadvantages, and explore some strategies for effective investment.

What is FLN?

FLN, or the First Trust Latin America AlphaDEX Fund, is an exchange-traded fund (ETF) designed to provide exposure to some of the most prominent companies in Latin America. The ETF follows the StrataQuant® Latin America Index, which uses an AlphaDEX® stock selection methodology to identify companies with strong growth and value characteristics.

This method deviates from traditional market-capitalization-weighted indices by focusing on factors like sales growth, price-to-book ratio, and return on assets, aiming to outperform the broader Latin American market.

Key Features of FLN

• Stocks from Brazil, Mexico, Chile, Peru, and other Latin American countries
• Incorporates both growth and value factors for stock selection
• Portfolio rebalancing to maintain desired growth and value characteristics
• Concentration in sectors like financials, materials, and consumer discretionary

The AlphaDEX® methodology helps to identify superior companies by employing a blend of growth and value factors, designed to deliver high returns.

FLN Composition

FLN's portfolio includes a diverse range of companies from major sectors such as financial services, natural resources, and consumer goods. Key holdings often feature well-known firms like Vale S.A., Petróleo Brasileiro S.A. (Petrobras), Grupo Financiero Banorte S.A.B. de C.V., and América Móvil S.A.B. de C.V. This blend offers investors exposure to large, economically significant sectors within Latin American markets.

Pros of FLN

Diverse Market Exposure

FLN offers broad exposure to key markets within Latin America, including Brazil, Mexico, and Chile. This geographical diversity helps mitigate country-specific risks and taps into various economic cycles and growth opportunities.

Growth Potential in Emerging Markets

Emerging markets like those in Latin America are often associated with higher growth potential compared to developed markets. FLN focuses on stocks with strong growth and value metrics, providing investors with an opportunity to benefit from the economic expansion in these regions.

AlphaDEX® Advantage

The AlphaDEX® methodology is designed to outperform traditional indices by selecting stocks based on growth and value criteria. This active selection process ensures that the fund holds companies expected to provide high returns, as opposed to merely tracking market cap-weighted indices.

Sector Diversification

FLN encompasses various sectors, with significant weight in financials, materials, and consumer discretionary. This sectoral diversity allows investors to capitalize on different aspects of the Latin American economy, from banking and finance to raw materials and consumer markets.

Cons of FLN

High Volatility

Emerging markets are inherently more volatile than developed markets due to political, economic, and currency risks. Latin American markets can be particularly susceptible to factors like government policy changes, economic instability, and commodity price fluctuations, making FLN a relatively high-risk investment.

Relatively High Expense Ratio

FLN has a higher expense ratio compared to some other ETFs, reflecting the cost of the active management involved in the AlphaDEX® methodology. Over the long term, these costs can eat into investment returns, making it less attractive to cost-sensitive investors.

Currency Risk

Investing in FLN exposes investors to currency risk. The local currencies of Latin American countries can be very volatile, and any depreciation can negatively impact returns for investors holding shares denominated in USD.

FLN Investment Strategies

FLN is tailored for investors who are looking to tap into the growth potential of Latin American markets but are prepared for the accompanying risks. Here are some strategies to think about:

Long-term Growth Strategy

For those willing to withstand short-term volatility, FLN can be an excellent addition to a diversified portfolio focused on long-term growth. Emerging markets may pose short-term risks, but history has shown that their growth potential can lead to substantial returns over the long haul.

Risk Mitigation Through Diversification

Investors interested in FLN should consider it as part of a more substantial, globally diversified portfolio. This approach helps to balance the elevated risks associated with emerging markets with more stable investments in developed markets.

Periodic Rebalancing

Given FLN’s exposure to volatile markets, periodic rebalancing can help manage risk. By adjusting the proportions of FLN in your portfolio periodically, you can ensure that your investment remains aligned with your risk tolerance and investment goals.

Hedging Currency Risk

To mitigate currency risk, investors might explore hedging strategies or invest in funds that provide currency-hedged versions. Although these options might incur additional costs, they can protect against unfavorable currency movements impacting returns.

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In conclusion, FLN offers a promising yet risky opportunity to invest in some of the key emerging markets of Latin America. While its AlphaDEX® methodology provides an edge by focusing on growth and value, the fund's high volatility and currency risk are important considerations. With appropriate strategies, FLN can serve as a valuable component in a well-diversified portfolio aiming for long-term growth.