Latin American markets have put in a stellar performance in recent months, and the spread of stability and democracy looks to be strengthening their hand. We invited a panel of experts to dinner to discuss the possibilities and the pitfalls of investing in Latin America.
Annunziata Rees-Mogg: Why has Latin America been doing so incredibly well?
Chris Palmer: Investors have been linking the Latin American boom to the growth of the Chinese economy over the past couple of years. Chinese demand for raw materials steel, various types of minerals is identified as a main driver. I can't say they're wrong, but it's not the whole story. We are, for example, seeing many years of political and social change in Latin America finally beginning to bear fruit, and it's no surprise that the most stable investment environment in many years has come at a time when the region has seen the spread of democracy. This is one part of the backdrop that isn't always visible to investors, but it plays an important role in medium- and long-term stability.
At the same time, some of the macro-economic policies of the last decade have blossomed too. More conservative fiscal policies and more realistic monetary policies by central banks have slowly helped the economies turn the corner. Now Mexican and Chilean government bonds have been upgraded to investment grade. Those countries are good examples of how a mixture of strong commodity prices, good fiscal policies and a more stable government come together to benefit the region.
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Ingrid Iverson: I agree, but coming from the debt side there are some other significant factors. First, the rally in the debt markets is now five or six years old. Bond markets saw benefits much earlier as countries adopted far more prudent fiscal policies. Now we are in a situation where there is very limited supply of bonds in fact, most countries are pre-paying debt and there seems to be still endless demand and the technicals of the market are very supportive. I now see spreads tightening selectively, country by country, rather than throughout the region as a whole. There are certainly countries that are still cheap in terms of fundamentals, but some are now looking more expensive. Elections also tend to weaken debt markets but any weakness after the elections will be a good opportunity to buy. Yet I agree that the political stability has been supportive to debt.
Mark Asquith: I would agree with Ingrid that the main improvement has been on the debt side, because we've mostly seen spreads tighten in government bonds. On the equity side, we've seen stockmarkets, such as Brazil's, up more than 250% in the past two years against a background of near-stagnant growth in GDP. Most people looking at how well the Latin American indices have done would assume progress was based on solid-to-high growth rates (as would be typical in emerging markets). But that hasn't been the case. The only reason Chile trades at such a premium is because some time ago it managed to get its finances in order. In Mexico, public finances are improving, but there is no growth story there, nor in Brazil.
ARM: How important are the politics specifically elections of Latin America?
CP: I almost completely disregard politics now in terms of the change of the politicians. The vital thing is that the process itself is respected by the parties who are involved and also that the infrastructure and the legal structures in the country and institutions around elections themselves are respected.
ARM: Ingrid, do you agree or do you think that the wave of socialism and nationalism is worrying?
II: I do wonder if we've all got a bit complacent. For example, [Venezuela's left-wing President Hugo] Chvez was freely elected and is popular but I don't think what he is doing for Venezuela is good. We keep buying Venezuelan debt because they've got oil, but you wouldn't want to take a ten-year view. Conversely, somewhere like Chile you probably could take a ten-year view because the institutions are that much stronger. I think the Mexican elections [on 2 July] will have an impact on how that country goes.
A: Politics matter. Basically, all of Latin America is looking red now, apart from Colombia. You've got a more moderate left in Brazil and Chile than in the [northern] Andean region. The crucial question, now that Latin America is seeing huge incomes flooding in from commodities and materials, is how the administrations will spend it. I think that you're likely to get more misspending under a more left-leaning regime than under a more right, or market-focused, regime.
CP: It's the quality of the spending that has to be judged. In these elections what we look for is not just who gets elected, but who comes into their government and what kind of people they can attract. If Alan Garcia, for example, is elected in Peru, I'm curious to see who he could attract to his government.
II: I have to assume that Garcia's learned from past mistakes [during his 1985-1990 presidency, which saw financial chaos and social unrest]. The crucial issue is growth. One of the most worrying things when we meet with finance ministry officials in places such as Brazil is their complacency about less-than-stellar growth rates of 4%-5%. They're almost more cautious now than the markets.
CP: There's certainly a striking difference between Brazil and Chile, where, in terms of a timeline, they are about ten years ahead let's say in terms of the political stability, the growth and the pension fund. Chile has an infrastructure that would solve many of Brazil's growth problems, not only because spending is good for growth, but because having an infrastructure can support exports.
MA: I have to say, I find these comments slightly surprising, in that they are being directed towards Brazil rather than Mexico. At least Brazil has part-privatised some of its utilities and energy sector and acknowledged the need for infrastructure spending, in contrast to Mexico's woeful lack of investment. In real terms, the Mexican export sector is a much greater percentage of GDP than Brazil's which has gone from 7% to 19% of GDP but Mexico is still inadequate, being hampered by poor infrastructure. Its railway lines don't even link up to US railway lines they're a different gauge and yet that's supposed to be Mexico's primary advantage, that it's next to the US.
ARM: Which are your favourite markets and which are your worst?
CP: I'm not going to argue in favour of Mexico right now, but it has got some of the best corporate management. The big problem right now is a three-party political system in a Congress that's not incentivised to pass legislation even by their own party whips. That doesn't mean there aren't some fantastic investment opportunities in Mexico, but it's a longer game. Increasingly, the dominant influence over Mexico is how the US economy is doing and what's going on in America generally.
There are two markets where we see exceptional potential particularly with regard to what's going on in China. One is Colombia and the other is Peru. Peru has great natural resources and mineral assets. It's an extension of the same belt of mountains that extends from Chile northwards and has a geology that favours energy. Yet even among the elite in Peru there is a lack of capacity to exploit the resources. In other words, Peru doesn't produce enough capital, people, machinery and wherewithal to scratch the surface of what they've got.
Colombia, too, is a resource-rich country (replete with oil, coal, emeralds) that has suffered from under-investment. It's also a cash-rich economy as a result of the drugs trade and it has a very respectable growth rate. Even during the worst parts of the insurgency in Colombia and when the drug trade was at its absolute height, it still had investment-grade status. Looking to the future, oil and coal seem to be underexploited and certain parts of Colombia have never been explored from a metals and minerals standpoint.
ARM: How do you see Venezuela?
CP: Venezuela is unusual in that it is one of the few Opec countries that has almost all of its refining capacities in the United States. Oil is Venezuela's main asset, but it has plenty of other minerals and resources as well natural gas, for example, and iron ore. So Venezuela is kind of a microcosm of Latin America: its politics are odd, but I would caution readers that when they hear of people not liking someone such as Chvez, they may be getting what I call the Miami view', which comes from the disenfranchised elite. This elite lost their personal advantage and access to the corridors of power. You can still do good business in the country.
ARM: What about Brazil?
MA: I am very pro-Brazil for much the same reason that Chris is pro the Andean countries; namely, commodities. Brazil is the most competitive in a lot of commodities. Not only does it have one of the highest grades of iron ore in the world, but it's got some of the fastest growing times for eucalyptus so its pulp and paper industry is exceptionally competitive. And when Brazil does things, it does them very rapidly.
For example, it went from being the 20th-largest producer of livestock in the world to the foremost in about five years because it's got vast stretches of land and it also has two harvests a year, so a lot of its soft commodities are exceptionally competitive. I remain very bullish on commodities, which are still only 17% of GDP, although there is a need for infrastructure development. But watch out for people saying Brazil is cheap it's not! If you look at the index p/e of nine times, over half the index comprises materials and utility stocks. There's froth in new listings in Brazil and they're very expensive.
ARM: So where is the best place to find value? Which bond, which company, or which country?
II: I think the best value is in domestic debt markets. Brazil is an obvious one if you can live through the volatility it will witness in the run-up to the elections [due in October 2006]. I think, though, that the real and fixed-interest bonds present good value. I also believe there's some value in Mexico too, because the peso has seen quite a correction. Peru is an interesting case if Garcia or Humala [the two candidates in the election run-off on 28 May] turns out to be another Lula, then it will look very cheap. If they turn out to be who they say they are, then it's probably expensive.
CP: We keep to a very simple strategy: we try to focus investments on the markets with the lowest forward p/e, such as Brazil. That said, none of what we've said today about Mexico is particularly bad, and none of what we've said about Brazil is a sure thing. This means that diversification is what the small investor should be looking for perhaps through an exchange traded fund (although my marketing people will hate me for saying so). For those who really enjoy putting on their crash helmet and investing in exciting stories, some of the things happening on Aim are quite exciting such as Emerald Energy (EEN) and Global Energy Development (GED).
MA: Global Energy Development has good management. There are plenty of others, such as Argentinian silver mining stocks, which some Latin American investors actually don't look at because they're on Aim. So I agree, Aim presents real opportunities.
CP: The problem is getting information on stocks but using Reuters (which is free) or going to a fund manager can be a useful way in.
MA: You can buy that knowledge too. There are some small brokerage houses that we use, mainly focusing on commodity and new energy companies, one of which is called Ambrian Research. They follow all of the firms we've been talking about.
ARM: Is there any important issue that you think we haven't covered and which our readers ought to know about?
CP: My big message here is that I believe the next 24 months will be a key period for Brazil, in terms of whether it can really democratise capital and make it over the wall' and head to where Chile is. I saw a guy driving a Porsche in Santiago with the top down, talking on his cell phone on an expressway, and I looked at that and said to myself, that can't be seen anywhere else in Latin America'.
MA: Can I add one last point on value in Brazil? You will get a score of utilities that have got yields higher than their p/e ratios and these utilities have the advantage of an improving regulatory environment and growth as well. The same goes for resource companies; you've not just got the growth, you've got some high yields of 18% or so.
