How to invest in Latin America: the emerging market that’s had a surprisingly good year

Before we get started this morning, just a reminder – if you haven’t yet read our emerging markets report (in association with Templeton Emerging Markets investment trust) then you can download it here.

On that topic – today we’ll be looking at an emerging market region which has been doing rather well this year. Given that stocks elsewhere in the world tend to be struggling a bit, that’s quite remarkable.

So why is Latin America outperforming – and can it continue?

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Latin America has had a surprisingly good year so far

2022 has been a rough year for most markets. But one is already enjoying double-digit gains year-to-date.

As the FT points out, the MSCI Latin American index is up by more than 15% already this year (in US dollar terms). By contrast, the MSCI All-World index (which covers both developed and emerging markets) is down more than 10%.

Latin America is a big area and it covers a wide range of countries with a wide variety of economic and political approaches. If we were talking about anything other than investment, I’d say that we were doing the region a disservice by generalising.

However, we are in fact talking about investment, and when it comes to investing, it pays to keep things simple. And the simple reality is that Latin America is a commodity play.

It might not always be that way. One day, Brazil in particular may fulfil its sardonic promise of being the “country of the future” and as a result you’ll get a more nuanced approach to investing in the region, as with southeast Asia, for example.

But that’s not where we are today. So given that the majority of people reading this are only ever likely to put a small proportion of the assets that they allocate to equities into Latin America, it makes sense to focus on the key drivers.

Latin America has done well this year for two main reasons. Firstly, markets in the region stood out as being relatively cheap. Secondly, commodity prices were soaring even before the Russian invasion of Ukraine, and Latin America produces a lot of commodities.

Brazil dominates the regional MSCI index, which is made up of five markets. It accounts for about two-thirds of the value of the Latin American index. The other big player is Mexico, on about a quarter. You then have Chile, Peru and Colombia.

Performance has been pretty volatile, but overall, Latin America has underperformed both the MSCI EM index, plus the MSCI All-World index, over three years, five years, and ten years.

Does that mean it’s due a break now? Investing’s not that simple. But it is undeniably cheap relative to its peers – at the end of February it was trading on a forward price/earnings ratio of 9.3, compared to 11.6 for the wider index, and 16.5 for the all-world one.

How to invest in Latin America

One benefit for Latin America is that it’s not really exposed to Russia or Ukraine in any significant way. As Nikhil Sanghani points out for Capital Economics, “the main economic effect of the crisis for the region will come indirectly via the impact on commodity prices.”

On that front, rising prices are a bit of a double-edged sword. Grain producers should benefit from higher prices, but high oil prices in particular will push inflation higher. Given that Latin America does not have the best record on that front, it’s worth keeping an eye on that side of things.

Politics is, of course, an issue, as with any emerging market. One big problem with resource stocks is that the more profit they make, the more tempted governments become to increase their tax rates (this is by no means purely an emerging market phenomenon – look at calls for windfall taxes in the UK).

However, given the combination of relative cheapness as well as relative appeal (as an area which is a bit more shielded from today’s geopolitical risks than many others), I’d say that the potential positives outweigh the negatives.

There’s a technical point that should work in Latin America’s favour, too. Until the sanctions kicked in, Russia was included in emerging market indices. Now the “Brics” (Brazil, Russia, India, China) have been reduced to the “Bics”. That means, in effect, that the index-tracking money that was allocated to Russia needs to be split between the other three.

Probably the easiest way for UK investors to invest in Latin America is via the BlackRock Latin American investment trust (LSE: BRLA), which is one of several investment trust picks that Max looked at in MoneyWeek magazine at the start of this year.

The trust has about 60% of assets in Brazil, 26.5% in Mexico, with Chile coming in a distant third on 6%. Financial stocks, materials and consumer staples make up the top three sectors. Brazilian miner Vale and Brazilian oil giant Petrobras are the top holdings. It currently trades on a discount to net asset value of about 9% and the dividend yield is 5%.