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Abu Dhabi, UAESunday 27 May 2018

Should investors turn their attention to Latin America once again?

The region has been largely ignored since the BRICS first captured the world's attention, but it is showing promise with Brazil the top performer

Illustration by Alex Belman
Illustration by Alex Belman

This year has been volatile for global stock markets with last week’s sell-off shredding investor nerves once again, but one region has enjoyed a surprisingly solid start to 2018.

Latin America, so often a byword for volatility, has defied crashing global stock markets and trade war threats so far this year.

Leading economy Brazil has grown strongly for two years and is the top global performer to date in 2018. So is now the time to give your portfolio a little Latin spirit?

Past glory

Investors have a habit of flirting with Latin America while never offering it long-term commitment.

The region last captured their attention during the emerging markets boom, when Brazil soared alongside fellow BRICs Russia, India and China, and Mexico reaped the benefit of signing the North American Free Trade Association (Nafta) with the US and Canada.

That party ended with the financial crisis and performance remained patchy until 2016, when the MSCI Latin America Index jumped 31 per cent, then grew another 24 per cent last year.

Mark Vincent, fund manager at specialist fund Aberdeen Latin American, says Latin America has endured a tumultuous few years, amid slumping commodity prices and corruption scandals, but now there are clear signs of recovery. “Policymakers have finally embarked on much-needed reforms and corporations have restructured. Global demand for commodities, led by China, is back. Foreign investor inflows are rising. The question is, can this momentum last? The signs are encouraging.”

Economic struggles

Brazil hit a low in 2012, ravaged by its worse recession on record, political corruption and high-profile arrests, but October’s elections could bring much-needed reform, Mr Vincent says. “First on the agenda are Brazil’s ruinous public pensions, which account for a whopping 12 per cent of GDP.”

Few countries have been hit harder than Argentina, Mr Vincent says. “In 2014, it defaulted on its debts, which plunged it into an extended recession and unleashed rampant inflation. It has now bounced back and the economy is primed to enjoy a credit-fuelled recovery.”

Mexico has been less volatile but it has been hit by President Donald Trump’s assaults on Nafta. “Its citizens vote for their president on July 1 and markets are concerned that a victory for populist left-wing candidate Andrés Manuel López Obrador could delay much-needed reforms.”

Chile has a comparatively stable regulatory system and as a major copper exporter has been lifted by the price of this important industrial metal, as has Peru, Mr Vincent says.

Jan Dehn, head of research at Ashmore Group, says Colombia is also showing signs of a cyclical upswing following a long slump caused by lower oil prices, uncertainty over its historic peace deal with Marxist Farc rebels and a lame duck administration. “Colombia now looks set to elect a business friendly president later this year, which is likely to unleash a great deal of pent-up investment,” he says.

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Quiet recovery

Nicholas Mason, co-manager of the Invesco Perpetual Latin American Fund, sees exciting times ahead for Latin America, amid rising stock markets, recovering economies and the election of market-friendly governments.

Many have focused on China’s resurgence while overlooking Latin America’s quieter recovery, which should continue amid rising corporate earnings. “In Brazil, consumption and investment continue to recover from depressed levels, while lower interest rates and subdued inflationary pressures should boost consumer demand,” Mr Mason says.

Mexico should benefit from President Trump's programme of tax cuts and fiscal stimulus, although protectionism remains a concern. “Nafta talks are moving forward but at a slow pace and the political temperature could rise as we head towards July’s presidential election,” says Mr Mason.

Will Landers, manager of the BlackRock Latin America Investment Trust, tips Brazil as the big story for 2018. “Argentina, Mexico and Peru also give us reason to be optimistic, with plenty of opportunities for investors.”

Economic outlook

Christopher Dembik, head of macro analysis at Saxo Bank, says now is a critical moment for emerging markets, including Latin America, which is now recovering from its “lost decade”, with Brazil outperforming every other major market year-to-date. “Latin America has started 2018 particularly well, with Brazil up 13 per cent, followed by Argentina up 6.5 per cent.”

Brazil is enjoying a U-shaped recovery despite lack of political progress and reforms, Mr Dembik adds. “Latin America is actually one of the only emerging areas where we expect growth to accelerate this year.”

While countries such as the US face resurgent inflation, this is less of a problem in Latin America, making it easier for central bankers to manage monetary policy.

Peru is moving in the right direction, driven by tourism and a developing high tech sector that looks set to boom.

Mr Dembik adds a note of caution as rising US interest rates and monetary tightening in Europe could squeeze growth globally. With global markets selling off amid threats of a global trade war, investors might want to keep their powder dry a little longer. “However, Latin America is in much better shape and is better equipped to face the era of monetary policy normalisation,” he adds.

Tom Anderson, senior investment manager at Killik, says Latin America has been on the cusp of becoming ‘developed’ for at least a century, but has never quite got there. “It has struggled to shrug off problems such as the unreliable rule of law, ephemeral politics and economies based on raw materials rather than added value.”

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Passive versus active

Many will still want exposure as part of a balanced portfolio Mr Anderson says, and the simplest way to do this is through a low-cost exchange traded fund (ETF) such as iShares MSCI Latin America ETF, up 34 per cent over three years (but like all funds mentioned here, down slightly if measured over five years).

Mr Anderson says those who prefer active management might consider Findlay Park Latin American Fund, up 29 per cent over three years, while BlackRock Latin America Investment Trust is up 37 per cent.

Vijay Valecha, chief market analyst at Century Financial Brokers in Dubai, notes that the IMF expects Latin American GDP to rise 1.9 per cent this year and then 2.6 per cent in 2019. “Rising private consumption and commodity exports support the positive outlook, alongside relatively low inflation, strengthening confidence and robust global financial conditions.”

He says you should invest no more than 5 or 10 per cent of your portfolio in the region, and tips the iShares Latin America 40 ETF, which follows the fortunes of the 40 largest companies in the region and is up 39 per cent over three years.

If you want a country specific fund, iShares MSCI Brazil Capped ETF is up an impressive 48 per cent over three years.

Oliver Smith, portfolio manager at IG Index, suggests balancing this with the newly launched Vaneck Vectors Brazil Small Cap ETF (0LLR), which targets smaller companies. “Small caps tend to be riskier than large caps but offer diversification from commodity and financial stocks, and should help investors benefit from the growing Brazilian middle-class.”

Russ Mould, investment director at AJ Bell, says investors should remember that Latin America remains a small part of the overall global economy and you do not need massive exposure. “Brazil, Mexico, Chile, Colombia and Peru combined make up just 1.5 per cent of the FTSE All-World Index, so it would not take a lot for your portfolio to be overweight in Latin America.”

He recommends actively managed funds Stewart Investors Latin America and Neptune Latin America, both of which have outperformed ETFs to grow an impressive 58 per cent over three years. Another active fund, BlackRock Latin American, is up 35 per cent.

For those who prefer low-cost passive ETFs he tips Amundi MSCI EM Latin America UCITS ETF, which has a very low total expense ratio of 0.20 per cent a year and is up 39 per cent over three years.

HSBC MSCI EM Latin America and iShares MSCI EM Latin America UCITS ETF both returned 34 per cent over three years.

Investment trust Aberdeen Latin American Income is up a similar amount and may tempt income seekers as it currently yields 5.07 per cent, although this is eroded by a high ongoing charge of 1.99 per cent a year.

A careful approach

Mr Mould says another option is to invest in a broader emerging markets fund with some Latin American exposure, such as Lazard Emerging Markets and JP Morgan Emerging Markets, which both have around 17 per cent of their portfolio in emerging markets.

Before you decide to invest in Latin America, it may be worth checking what exposure you have in any existing emerging markets funds.

Latin America is enjoying its revival but Mr Mould warns that it will remain risky, given this year's elections. “Concerns over trade wars and President Trump's ‘America First’ policy continue to linger, while some will want to wait for the results of the Mexican and Brazilian elections.”

A slowing global economy and falling demand for commodities would hit the region, which is still dependent on exports of minerals and metals. Faster than expected increases in US interest rates and an escalating trade war could pose another threat, as they do to every economy in the world, including the US.

Any global slowdown would not spare Latin America, which is likely to remain volatile for years to come. However, for long-term investors who appreciate the dangers, it may be time to join the party.