For intermediaries this leaves two key questions to consider. Does the potential justify the risks of investing in what can undoubtedly be a highly volatile market? And if so is now the right time to invest?
Mark Mobius, the head of emerging markets at Templeton, argues that what many perceive as a weakness actually indicates a recent strength of Latin America. “The fact that the
re’s not been much contagion from Argentina is a plus point,” he says.
The well publicised problems in Argentina – including the collapse of the peso and turmoil in the banking system – have hardly spread to other countries in the region.
This is in contrast in the past when problems in the larger Latin countries – and indeed in other emerging markets - have often moved from country to country. “It was quite impressive how Brazil decoupled from Argentina this time,” says Shahreza Yusof, an emerging markets fund manager at Aberdeen.
It is also easy to overestimate the importance of Argentina itself in Latin American investment. Despite its strength as a footballing nation and its position as the third most populous nation in the region it only accounts for 2% of the MSCI Latin America index.
Two dominate
In contrast, Brazil accounts for 36% of the MSCI index and Mexico represents 47%. These are the two countries which matter when considering investment in the region.
The importance of Mexico also raises another plus point for Latin America. Since the implementation of the North American Free Trade Agreement in 1994 its economy has become increasingly integrated with that of its northern neighbour. “Mexico is converging handsomely with the US,” says Emily McLauglin, a Latin America manager at F&C Management.
In particular many American companies are setting up operations in the “Maquiladora belt” on the Mexican side of the border with the US. “The hot, heavy jobs are shifting south of the American border,” says Ms McLaughlin.
For investors this means that Mexico seems to combine the security of close links with the US combined with the potential of an emerging market. If the bulls’ case is right it certainly presents a powerful case for investment in the region.
This also seems to be a good time to invest in Latin America. Emerging markets tend to benefit from cyclical recoveries in the global economy. So if the world is recovering – and there is still some argument about whether there will be a “double dip” return to recession – the region should enjoy a boost.
Potential problems
Although there are many attractions to investment in the region at present it is important not to lose sight of potential problems. Perhaps the most important of these is what could be referred to as political contagion.
Many investors and potential investors fear that Latin America could return to its days of radical populism. An upsurge against the governments which are routinely condemned as “neo-liberal” could easily unsettle investors.
Last month’s turmoil in Venezuela, with a coup followed by a counter-coup within 36 hours, was certainly watched with anxiety by the financial community. Although Venezuela only accounts for 1% of Latin American markets there were fears it could indicate a pattern that is emerging in the region.
If the Workers Party wins the elections in Brazil in October it would certainly have a far greater impact. The prospect of a radical left wing organisation governing the region’s largest economy certainly worries fund managers. Indeed over the past three months the Brazilian currency has fallen significantly as a result of such fears.
However, many informed observers believe that the risks of such an upsurge are exaggerated. Despite the radical rhetoric of some opposition movements there is – in contrast to the past – an almost universal belief that the market system is the best way to organise the economy. Even the Brazilian Workers Party is unlikely to be as radical in government, should it get elected, as many fear.
Right fund
Naturally the state of the markets is not the only consideration for any potential investors in Latin America. If the case for the region is accepted then it is vital to find a fund that invests in the right companies.
Dominic Rossi, the manager of the Threadneedle Latin America fund and the only Latin America manager to currently hold a Morningstar five star rating, has a particularly systematic approach. In his view the key to investing in the region is to take into account the high cost of capital for companies.
This means investing in a concentrated portfolio which avoids smaller companies – since they cannot raise relatively cheap finance on the bond markets – and many of the smaller countries in the region. He then looks for companies he believes can beat their cost of capital on a sustainable basis.
Although Ms McLaughlin of F&C is also wary of smaller companies she is a little more accommodating towards them. Her stock section process starts with an examination of global sector research and macroeconomic trends.
Those who are willing to take a chance in investing in Latin America certainly have the potential to make good returns if they bet on a fund manager who makes the right calls. In contrast those who feel uncomfortable with the risks that such investment involves at least have the consolation of enjoying the spectacle of Latin American football at the World Cup.
This article first appeared in the May 20th issue of Fund Strategy.
