Opportunity in Latin American emerging markets?

It’s been a turbulent 12 months for Latin America’s emerging markets.

Ongoing corporate corruption investigations across the regions emerging markets, Alberto Fernández’s surprise left-wing victory in the Argentine election primary, widespread anti-government protests in Chile and Ecuador, and alleged voter fraud in Bolivia have all given emerging markets investors in the region reason to pause.

As a result, the regions’ emerging markets have been left vulnerable to currency, stock and bond sell-offs and a lack of investor certainty as nations deal with ravaged cities, new governments and, in some cases, rewritten constitutions. These factors have compounded the risk of investing in regions’ emerging markets which, over the last five years, have seen some of its biggest companies, including Brazilian oil behemoth Petrobras, Mexico’s Pemex and construction groups Odebrecht (another Brazilian firm) and Peru’s Graña y Montero, directly linked to some of the world’s biggest ever bribery cases.

 

Clamp down on corruption

And yet – there is still appetite for Latin American emerging markets investment. As the Brazilian police force’s so-called Lava Jato (Operation Car Wash) investigation continues to unravel the full extent and reach of the Petrobras scandal, a tidal wave of resultant corporate anti-corruption drives across the region have followed, including wholesale revamps of company structures, not least at Petrobras itself.

This clean-up has resulted in a cautious confidence within the regions’ emerging markets. The S&P Latin America 40, made up of companies from the area’s four major markets, has risen from a 2019 low of $2,908.28 in August to hit $3,360.90 as of 10 January.

Brazil has seen the highest net inflows into equity funds in 10 years and the iShares Latin American 40 ETF returned 10.2% in 2019. Investors in the region’s largest ETF, iShares MSCI Brazil (EWZ) ETF saw a 35% year-on-year rise from $34.24 to $46.27 (as of January 10) – triple the 11.38% gains seen from the iShares MSCI Emerging Markets [EEM], which tracks emerging market stocks, over the same period.

                                                

All eyes on Brazil

In Brazil, a swathe of social and economic reforms by President Jair Bolsonaro – including seismic pension and tax reforms and an overhaul of the country’s social security system – has reassured investors for the year ahead.

With Brazil’s chief economist Paulo Guedes – and founder of Sao Paolo investment firm BTG Pactual – setting an agenda that brings interest rates down, locals are eschewing government bonds and savings accounts to invest in hedge funds and equity funds. This boosted the Bovespa almost 32% in 2019 from BRL87,887 to BRL115,964 – and better than expected inflation figures at the start of January has seen stocks continue to rise. Other Brazil-focused ETF’s have also performed well –  among them the iShares MSCI Brazil Small-Cap ETF [EWZS], which has jumped 35.5% since this time last year, from $15.94 to $21.60 as of 14 January.

However, foreign investors are not so confident – they pulled around BRL4.1bn out of Brazil stocks in 2019 and are holding back to see if Bolsonaro’s radical policies will turn a soaring stock market into stability. Foreigners “haven’t yet re-risked their Brazil exposure,” said Morgan Harting, a portfolio manager at AllianceBernstein in New York. “That’s a combination of global portfolios just being more defensively positioned and some scepticism about how much more room to run there is in Brazil, particularly as the GDP growth rate (forecast at 1% for 2020) still seems pretty sluggish.”

“That’s a combination of global portfolios just being more defensively positioned and some scepticism about how much more room to run there is in Brazil, particularly as the GDP growth rate (forecast at 1% for 2020) still seems pretty sluggish” - portfolio manager at AllianceBernstein, Morgan Harting

 

Beyond Brazil

Among the region’s other notable achievers is Colombia, whose COLCAP market index has gained 19% over the last 12 months, an upward trajectory seemingly set to continue – banking giant Grupo AVAL gained 29% and rival Bancolombia 25%. This was down to larger than expected GDP growth of 3.3% thanks to higher consumption resulting, somewhat surprisingly, from a significant influx of Venezuelan refugees. This, in turn, boosted the peso and the country’s largest specific ETF, Global X MSCI Colombia, from $8.57 to $9.98 in the past 12 months.

Elsewhere in the region, civil unrest may play a part in Colombia’s future with farmer blockades potentially disrupting oil supplies. Yet growth forecasts remain high at around 3.6% for the next two years.

Other country-specific ETFs have had mixed results over the past year – the iShares MSCI Peru ETF has risen 0.2% to $36.32 as of 10 January, and the Mexican equivalent 4.3% to $46.39, while the iShares MSCI Chile Capped ETF is down 22.5%.

Faring far worse is President Fernández’s Argentina. The economy is forecast to shrink 1.3% – contracting for the third year in a row – while inflation is rampant, rising 52% in the last 12 months. Meanwhile, the peso has plunged 80% since 2015 and was the world’s worst-performing currency last year. Finally, the country’s MERVAL Index plunged a spectacular 48% in just one August day in 2019 in the aftermath of the election result.

  

However, the market has rallied since, with the MERVAL soaring from ARS23,079 to ARS42,035 since September, and is continuing to rise – potentially echoing the country’s last economic crisis in the early 2000s when the MERVAL crashed 60% in eight months before rising 330% over the next three years. But it would be a brave investor to take on such volatility, which is likely to last well into 2020 – and at least until Fernández, who finally officially took office in December, announces how he will tackle the country’s $100bn debt pile.

 

Returns – for the brave

Latin America, like anywhere else, has the potential to reward investors – so long as they are willing to stomach the risk involved. “An investment in Latin America over the last two decades has rewarded investors with a return of 776.3%,” says Joseph Hill, investment analyst at Hargreaves Lansdown. “Of course past performance isn’t a guide to future returns, and those returns haven’t come in a straight line, but with steep falls and sharp rises.”

“An investment in Latin America over the last two decades has rewarded investors with a return of 776.3%. Of course past performance isn’t a guide to future returns, and those returns haven’t come in a straight line, but with steep falls and sharp rises” - investment analyst at Hargreaves Lansdown, Joseph Hill

 

Ed Kuczma, co-manager of the Black Rock Latin America Investment Trust, cites the potential of the region: “Each country within Latin America has exciting areas of growth.” However, he cautions that these ”need to be hand-picked.”

With new regimes, policy reforms and political unrest – not to mention other factors such as the wider global economic slowdown and unresolved US trade tensions with Latin America’s biggest market, China – it’s no surprise that even analysts warn the only certainty about the region is uncertainty.