Latin America... Refocusing on Fundamentals
Looking Beyond the Turmoil in the Pursuit of Long-Term Growth Opportunities
Firstly, let's get some of the noise out of the way.
Latin America, has seen better days. Brazil, which accounts for around 55 percent of the region's market cap, has been in political disarray over the past several months. Media coverage surrounding localized diseases and ill preparedness for the Olympics, has painted the country in an even more negative light. However, the temporary suspension of Dilma Rouseff, in May, 2016, and the installment of interim President, Michel Temer, has made a world of a difference in cooling investor jitters surrounding the country. The rally in commodity prices has also helped. With global investors returning to Brazilian bonds and equities, the Brazilian real has been one of the best performing currencies year-to-date. Brazil's Bovespa Index has also been one of the strongest performers globally in 2016. We believe there are key fundamentals in place which position Brazil and other major Latin American nations for further outperformance. These factors are discussed in greater detail below.
It's worthwhile to point out that developed-market nations are not entirely immune to sociopolitical instabilities that can send shockwaves through their own financial systems. Look no further than Britain's recent and unexpected vote on June 23rd 2016, to leave the European Union, and the ensuing fallout. The political wrangling for Britain to leave the EU bloc is expected to take a minimum of two years to complete, casting a cloud of uncertainty over what is considered one of the world's most sophisticated markets. The consensus view now, is actually that 'Brexit' will push investors that are searching for stronger returns into the emerging markets and regions like Latin America, as they are unable to find real growth opportunites in more mature economies.
It should hardly come as surprise then, that in the face of all this clamour, emerging markets outperformed in the second quarter of 2016, driven primarily by strength in Latin American equities. For Q216, the MSCI Emerging Markets Latin America Index advanced 5.5 percent, while the MSCI Brazil Index returned approximately 14 percent – see the below chart.¹
On a year-to-date basis, the performance is even more impressive with Latam equities returning a positive 18 percent and Brazilian stocks giving back a positive 38 percent, in CAD terms, through June 30, 2016.¹ You might be asking yourself, where was I on this trade?
If you know your history on Latin America, you will be very much aware of the fact that prior periods of crises have actually been followed by sustained spells of strong stock-market performance. Take a moment to examine the table below¹:
The Excel Latin America Fund offers Canadians a unique opportunity to invest in this high-growth region, which is poised for a recovery.
Fundamentally, we believe that Latin America is both a 'value' and 'earnings turnaround' story. Brazil's investment thesis is based in part on an expected decline in the cost of capital, in that, interest rates are currently around 14.25 percent, while inflation has been slowing towards the central bank's target range and is now down to around 8.8 percent.² As a result, that gives the Brazilian central bank flexibility to reduce interest rates further, potentially by as much as 200 – 400 basis points over the next 12 months. This should bode well for corporate earnings and investors in the Brazil over the long run. As mentioned earlier, structural regime change will also serve as a tailwind, as a new market-friendly administration will move to control the budget deficit and improve economic conditions.
Meanwhile, Mexico, which accounts for around 30 percent of the region, is considered a relative bright spot within the region – the Excel Latin America Fund is approximately 30 percent allocated to Mexican equities, as at June 30, 2016. Mexico continues to achieve positive GDP growth figures, last recorded at 2.6 percent year-on-year in the first three months of 2016.² Furthermore, domestic consumption has been picking up as inflation holds near record-lows and banks increase access to credit. Mexican consumers tend to have minimal household debt and therefore more disposable income to help continue to spur growth.
Manufacturing is also one of Mexico's strong suits as the country is among the top 10 exporters of automobiles across the world. Of note, commodities only account for 15 percent of total exports, meaning Mexico is far less dependent on oil compared to its peers in the region.³
Many of the remaining Latin American countries, Chile (heavy investment in copper), Colombia (focused on infrastructure) and Peru (rising business sentiment), are also achieving positive GDP growth rates. However these nations are by no means homogenous and investors therefore need an active manager with boots on the ground, to spot opportunities that often exist in fragmented sectors.
The Excel Latin America Fund is sub-advised by Itaú USA Asset Management Inc., which is among the largest asset managers in Latin America with over 50 years of investment experience, and ranked as the number one privately-owned fund manager in Brazil.⁴
Scott Piper, the portfolio manager and sub-adviser lead, generates alpha by focusing on secular growth companies. "The reason people buy emerging markets or Latin American funds is because they want more growth," notes Mr. Piper. "[We invest in] that profile of company that is young and emerging, that is a leader in it's sector. That is the kind of growth of opportunity that we are trying to take advantage of." Mr. Piper, also goes on to explain that he attributes the term "secular growth" to companies that can "generate strong free cash flows, above market averages, and through cycles over a 3 to 5-year period."
The trend of Latin American markets is currently positive. A favourable outlook for the region, which includes cooling inflation across the board, the introduction of more orthodox governments in larger nations such as Brazil and even Argentina, along with consumption pickup and stabilizing commodity prices, make for an attractive combination that investors should seriously consider if they are looking to enhance the long-term returns in their portfolios. When it comes to investing in Latin America, we urge investors to focus on these long-term fundamentals.
To learn more about investing in Latin America with Excel Funds click here.
¹ Bloomberg data, accessed on July 18, 2016.
² Trading Economics data, accessed on July 15, 2016.
³ Itaú USA Asset Management Inc., as at December 31, 2015.
⁴ Associação Brasileira das Entidades dos Mercados Financeiro e de Capitais (ANBIMA), October, 2015.