Invest in a top economy of the future

The massive infrastructure investment programme will provide a number of investment opportunities, according to Dean Newman, head of emerging market equities at asset manager Invesco Perpetual. The Brazilian government will spend £8.6bn on the World Cup and £7.3bn on the Olympics which are part of the wider Growth Acceleration Program which also focuses on increasing the country’s energy production capacity, homes and schools, and improving transportation, water, electricity, sewage, security and urban mobility.

"We favour consumer related stocks, such as homebuilders and real estate companies," says Mr Newman. "While these companies are set to benefit from the improvements ahead of the World Cup and Olympics, they should also prosper from the ongoing Growth Acceleration Program. Another area where we expect to generate strong returns is our exposure to airlines and food, beverages and tobacco."

In addition, last week the Brazilian government announced a further $65.6bn stimulus package to increase investment in infrastructure.

Thomas Smith, fund manager of the Neptune Latin America Fund, believes the infrastructure investment could have longer-term benefits. "While the absolute level of investment may not have an immediate meaningful impact on Brazilian gross domestic product (GDP), the accelerated investment in projects such as airports and roads will help remove infrastructure bottlenecks and raise Brazil's trend growth rate over the medium term," he says.

And investors are positive on Brazil's long-term growth for reasons other than the Olympics and World Cup. The country has an emerging middle class which is boosting domestic consumption and credit growth. The banking system is robust cutting the risk of credit disruption, while debt is relatively low at government, corporate and household levels. The country also has a youthful population relative to ageing developed economies.

Recent discoveries, meanwhile, could make Brazil a major oil producer by 2020.

Brazil is also the largest exporter of soft commodities and China has become its top export destination. "High soft commodity prices should help the trade balance and the wealth in the interior while higher commodity prices will generally benefit Brazil as it is a material producer and exporter of soft and hard commodities," says Slim Feriani, chief executive officer of asset manager Advance Emerging Capital. "But the domestic economy remains more important than exports, which account for barely 12 per cent of GDP, although there is a perception that Brazil is all about commodities."

Domestic services account for 60 per cent of Brazil's GDP.

Inflation, a problem in the past, is currently under control and strong employment is leading to domestic growth.

The Brazilian stock market is also at historically low valuations so could present a buying opportunity. "Brazil is touching the valuation lows reached in 2008," say Luis Carrillo and Sebastian Luparia, managers of the JPMorgan Brazil Investment Trust. "The market as a whole is currently valued at close to 1.5x book value, a level only reached previously at times of crisis. Historically, these levels have proven attractive entry points for investors with anything more than a one year investment horizon."

The average company price/earnings ratio (PE) for 2012 is currently below 10 in Brazil despite attractive growth in earnings per share, adds Laurent Deltour, chairman of Sycomore Asset Management.

Managers are using this opportunity to top up holdings, for example, Aberdeen Latin American Investment Trust has introduced retailer Hering which its managers say is at an attractive valuation, and Brazilian miner Vale following price weakness.

Paul Marson, chief investment officer at private bank Lombard Odier, says the country is their most favoured emerging market at the moment due to the attractive valuations.

Bric fundamentals

Over the 10 years to the end of 2011 the MSCI Brazil index has experienced the greatest cumulative growth of the four Bric nations, increasing 561 per cent, well ahead of nearest rival India up 323 per cent.

The Brazilian market is more diverse than Russia as it is less commodity focused, and produces a lot of soft commodities rather than mainly oil and gas.

"There are a lot of different sectors now represented on the stock exchange," says Michael Konstantinov, manager of the Allianz RCM Brazil Fund. "In terms of domestic demand, as well as from the pure retail and healthcare sectors, we are seeing, for example, housing and property-related companies which are catering very much for the low income housing market. That differentiates the Brazilian market from many other emerging markets because it has grown in terms of its depth and investment opportunities."

Another attraction is the growing dividend yield on some companies. "Brazilian companies listed on the local exchange, BM&FBovespa, are required to maintain a minimum 25 per cent payout ratio," says Sophia Whitbread, fund manager at Newton. "This has led to an established dividend culture among the local corporates, with the BM&FBovespa currently yielding over 4 per cent."

Risk

The economy expanded 7.5 per cent in 2010, the fastest pace in more than two decades, but last year slowed to 2.7 per cent and this year is expected to grow 2 per cent or less.

However, like all emerging economies Brazil is higher risk as well as potentially higher return. Emerging markets shares can be very volatile.

Although Brazil is a democracy unlike some emerging markets and the level of corruption there is less than countries such as Russia and China, it is still not as good as in developed countries.

Inflation could rise again and limit the Brazilian government's ability to continue to lower interest rates, which now stand at a record low of 8 per cent.

"In Brazil we find relatively few companies that both meet our quality based criteria and are cheap enough to achieve our return ambitions," adds Jonathan Asante, co-manager of First State Latin America Fund. "We consequently don't own many companies there. We are sceptical that Brazilian policy makers are not going backwards in terms of weakening fiscal discipline and increased government intervention in the economy and the need to build lots of infrastructure seems to potentially exacerbate these concerns. We are also acutely aware of Brazil's commodity dependence which would expose these and other structural weaknesses further, probably leading to significant currency weakness."

To what extent the country will benefit from the World Cup and Olympics is questionable. While there will be a short-term bounce for some companies the total benefit is difficult to quantify.

"There has been a notable correction in emerging currencies generally and the Brazilian real in particular during the past few months," say the managers of JPMorgan Brazil Investment Trust. "We believe this was driven more by investors reducing risk than by fundamentals alone, though in Brazil the government has been promoting a weaker, more competitive currency. Although consumption remains robust industrial production has been stagnant despite unemployment reaching new lows. This is in part due to the continuing effects of the strong currency. Expectations for earnings growth are weak, but government policy is very pro growth so we expect a gradual recovery in activity and earnings as the year progresses."

GDP is slowing to 2.1 per cent this year and 3.1 per cent in 2013, according to Tim Ohlenburg senior economist at the Centre for Economics and Business Research. This is in contrast to more than 7 per cent in 2010.

As a commodity exporter with particular exposure to China Brazil could be hard hit if there is a slowdown in China.

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Latin America investment trusts

Source: Morningstar. Performance data as at 17 August 2012

Latin America funds

Source: Morningstar. Performance data as at 17 August 2012