With rising consumption, infrastructure investment and the prospects of higher returns on equity than its peers, perhaps now is the time to look at Latin America.
Changes that have made a difference
First of all, why the turnaround? It is true many investors have been wary given the political and financial crises that hit the region in the 1980s and 90s – but the economic transformation since has created significant investment opportunities.
This change has been driven by a commitment to control inflation and fiscal integrity, and supported by strong commodity prices and demand.
As a result, the country risk premium for Latin American equities has fallen, attracting increased foreign investment to its key markets.
The region has also benefitted from privatisation and deregulation of some sectors, trade liberalisation, a gradual improvement in solvency ratios and a substantial improvement in the structure of sovereign debt dynamics – pragmatism that has
benefitted Latin America enormously through the recent crisis.
Commodities are important, but not the whole story
Although commodities play a major part in the Latin
American economy, the perception of their importance is probably even higher. While it is true energy and materials stocks make up just over 40% of the region’s benchmark, largely as a result of the dominance of Brazilian giants, Petrobras and Vale, exports in total represent only 20% of Latin American GDP. Consumption, meanwhile, accounts for 62.8%.
At the top end of the scale Chile’s exports make up 30% of its GDP, with commodities comprising 77% of these exports. In contrast, Brazil, widely perceived as a commodity behemoth, has exports representing merely 10% of GDP, with commodities contributing just half of this figure.
Therefore, while Latin America’s exposure to commodities is relatively high, particularly
from an index perspective, the region is, in fact, neither dominated by commodities nor exports.
Perhaps surprisingly it is the consumption theme that looms largest and provides many of the region’s most attractive opportunities.
Creating a virtuous cycle
In fact, the key reason investors should consider an investment in Latin America is the growth in domestic consumer demand. Secular changes in the region’s economy are boosting household incomes, creating a burgeoning middle class that in turn is spending more on consumer goods and discretionary items.
In Brazil for example, a 20% decline in those living below the poverty line from 2002-2007 means that over 30 million people are now beginning to buy their first homes, cars and white goods and increasing overall expenditure – a trend expected to escalate.
It is likely the domestic sector will be further powered by rising investment. Historically, Latin American countries have underinvested, spending around 20% of GDP, compared to 45% in China. This has resulted in severe infrastructure bottlenecks, limiting the region’s growth potential.
But with lower real interest rates, a more stable business environment and solid government balance sheets there are reliable catalysts in place to encourage private sector investment and give the public sector the means to invest in infrastructure. These in turn, initiate a multiplier effect across many sectors, boosting employment and incomes, and providing further stimulus to domestic consumption.
A smart way to explore Latin American potential
Importantly, there are now many ways for investors to capture the opportunities offered by Latin America’s transformation. Although the Latin American index maintains a high commodity company weighting, over 150 IPOs over the past five years have opened up diverse new investment opportunities.
And with countries rebounding strongly from the financial crisis, the rationale behind exploring the region has considerable merits.
Investment trusts have, over the years, proved very adept at exploiting the profit potential of emerging markets. Investment trust managers can take advantage of their closed-ended structure and take a longer-term view without having to adapt to the potential of short-term, and often considerable, fund flows.
This helps investment trusts in companies that may be less liquid, broadening the investment universe from which they can choose stocks. This trait also helps managers be more active as they have the freedom to pursue (often rapidly growing) companies that lie outside of an index – particularly important in Brazil for example where Petrobras and Vale make up approximately 40% of the market’s value.
The result is
investment opportunities that fully reflect the region’s transformation and take advantages of the opportunities now being created.
These facets coupled with typically lower fees show why investors should consider investment trusts when pursuing the investment potential Latin America now offers.
Luis Carillo is Luis Carrillo, manager of the JPMorgan Brazil Investment Trust
