Looking to Latin America for Olympian returns

The Olympic Games could be a major boost to Brazil's economy. But far more important has been the market's reaction to the impeachment of president Dilma Roussef following a long-term corruption scandal, protests, and years of slow growth and high unemployment. And seismic political change across Latin America has been instrumental in driving recent stock market surges and is the central case for investing now.

Leftist governments in countries including Brazil, Venezuela and Argentina, who focused on spending and social programmes but become synonymous with rampant inflation, protests and weak growth are crumbling. In their place are new regimes determined to reduce spending, cut public debt and lure back foreign capital to their shores. Whatever your politics, the promise of real structural change combined with higher commodity prices and a slower than expected rate tightening from the US could make now a good entry point.

Jan Dehn, head of research at asset manager Ashmore, says: "Having been beaten up more than any other region during the headwinds of the past few years, Latin America now offers perhaps the most interesting investment proposition in the world.

"Institutions are improving, populist governments are giving way to more market-friendly administrations and asset prices are cheaper than elsewhere. Latin America will also see more a more extreme turnaround in growth than other regions over the next couple of years."

Based on the rock-bottom estimates for Latin American company earnings growth and return on equity, "It is possible that Latin American stocks will climb substantially higher," says Gary Greenberg, head of emerging markets at Hermes.

And Mr Dehn believes that investors should allocate now to avoid missing a once-in-a-decade opportunity.

Hope means risk

But investing in the hope of political change is a risky game. Markets might already be overly optimistic and have rallied too far, considering how long any reform could take.

Argentina's stock market rallied 380 per cent between the demise of Cristina Kirchner's presidency in mid-2013 and the election of Mauricio Macri in 2015. In Brazil, "a powerful combination of falling risk premia and forward rates since February – well ahead of any recovery in earnings – shows how much the market is anticipating change," adds Mr Greenberg.

Jason Hollands, managing director at Tilney Bestinvest, says: "I think some of the exuberance has been overdone. Markets get excited about political shifts but there are still serious headwinds facing these economies due to built up financial problems and the exposure, particularly in Brazil's case, to commodities." He points to the 2013 Indian stock market rally following the election of reformist prime minister Narendra Modi, which reversed two years later when his policies hit unexpected hurdles.

But Latin America still has a long road to real recovery. Brazil, which makes up over half of the MSCI Emerging Markets Latin America index, suffered its biggest gross domestic product (GDP) contraction in more than 20 years in 2015, when it shrank by 3.8 per cent. Now over 11 per cent of its workforce is unemployed. In Argentina, meanwhile, president Macri has made strides but the country's central bank has still been forced to hike short-term interest rates to above 35 per cent to rein in inflation. And Venezuela is mired in fresh turmoil over its leadership.

Brazil funds

There is not a wide choice of single country Brazil funds, but options include JPMorgan Brazil Investment Trust (JPB). This was launched in 2010 and has not rewarded investors since then, having lost 37.3 per cent against a fall of 19 per cent for the MSCI Brazil 10/40 index. It has also failed to beat this index over one and three years.

The trust aims to invest in companies benefiting from the growing middle class and the rise of consumer spending in Brazil, and avoids companies "unduly subject to political influences." As a result it does not hold Petrobras (PETR4:SAO) or mining stock Vale (VALE5:SAO), but in recent months that has detracted from performance. However that helped in 2015 when Petrobras declined 46 per cent and Vale fell almost 60 per cent.

The trust's manager prefers quality and domestically-oriented stocks, so it is invested largely in strong consumer and industrial franchises. Financials is the largest sector allocation, accounting for almost one-third of the portfolio.

Charles Cade, head of investment companies research at Numis Securities, says: "JPM Brazil has been a disappointing investment since launch in 2010. The discount has been controlled, helped by an active share buyback policy, but the fund is now sub-scale with a market capitalisation of just £21m and we believe its long-term future is in doubt. However, it is the only investment trust focused on Brazil and we believe it is an attractive way to get access to a market that has the potential for a sustained rally if there are signs of meaningful economic reforms."

The trust has capped its ongoing charge at 2 per cent of assets and removed its performance fee. It trades on a discount to net asset value of 7.8 per cent.

Latin American funds

Of the open-ended equity funds invested in Latin America, the top performers over five years are Stewart Investors Latin American Equity , Aberdeen Latin American Equity (GB00B4R0SD95) and Neptune Latin America (GB00B909HH53). Stewart Investors Latin America Equity returned the most over that period with 32.4 per cent, however that fund is now soft closed.

Aberdeen Latin American Equity has returned 3.3 per cent over five years and 61.7 per cent in the year to date. "Aberdeen's emerging markets team are world renowned and Aberdeen Latin American Equity fund showcases their methodical investment process," says Darius McDermott, managing director at FundCalibre. "Stock selection is entirely based on fundamental research and four to five company visits are typical before an investment is made. This diligent approach is well suited to the volatile nature of emerging markets."

It has 60 per cent of its assets in Brazil and 21 per cent in Chile. Its largest holding is Banco Bradesco (BBDC4:SAO). With just 39 holdings the fund is fairly concentrated and it is also highly weighted towards financials, which account for 34 per cent of its assets.

Over the long term Fidelity Latin America (LU1033664027) has held up the best of all Latin America funds in the Investment Association (IA) Specialist sector. However in the short term it has performed less strongly. It is heavily invested in financials and beverages - its largest holdings are Mexican drinks company FEMSA (FEMSAUBS:MEX) and Brazilian beverage giant Ambev (AMBEV3:SAO).

Investment trust options include Aberdeen Latin American Income (ALAI) and BlackRock Latin American Investment Trust (BRLA).

Lee Robertson, chartered wealth manager and chief executive offier at Investment Quorum, does not currently invest in Latin America, but says: "If we were ever to go back into the region, the fund we might look at would be BlackRock Latin America Investment Trust."

This trust has lagged its index over the long term and so far is failing to match the gains made this year. Manager Will Landers has attributed that to underweight positions in Chile, which was one of the strongest performers in the last calendar year, and an overweight position in Peru. However, he has increased positions in Brazilian bank Bradesco and says Brazilian financials now offer good value.

The trust also pays out a healthy income and yields 3.7 per cent, while in recent years its dividends have been well covered by revenue reserves and earnings.

Aberdeen Latin American Income has an even higher yield of 5.5 per cent. The fund aims to generate growth and an "above-average yield" through equities and fixed-income assets. Its 10 largest bond holdings include five Brazilian sovereign bonds with a range of maturities, as well as Mexican, Colombian and Peruvian debt.

Its largest equity holdings include Ambev and FEMSA, which recently acquired 49 convenience stores in Chile, boosting its footprint in the country by 6 per cent. The trust was launched in August 2010. It does not benchmark against an index but compared with the MSCI Emerging Markets Latin America index it has tended to underperform in down markets and outperform in rising markets. With just 56 holdings the trust is quite concentrated and fairly high risk.

Risk

Despite some of the positive fundamentals for Latin America, investing in this region incurs a number of risks. "These markets are far riskier than a global emerging markets fund," says Mr Hollands. "These are very high-beta markets and are quite concentrated on commodities, and most funds will tend to be weighted towards financial institutions. Corporate governance in the region is also very poor and the politics are very volatile."

MSCI Emerging Markets Latin America is more volatile than MSCI Emerging Markets index both over the short and long-term. According to data provider FE Trustnet, returns from MSCI Emerging Markets index have been 10 per cent less volatile over three years compared with MSCI Emerging Markets Latin America index.

Of the Latin American countries that have MSCI indices, Argentina has been the most volatile over 10 years. It has also experienced the biggest falls from peak to trough (maximum drawdown). The maximum investors would have lost in that market has also been highest, at more than 50 per cent.

The least volatile market is Chile over a 10-year period, which also boasts the smallest maximum loss and drawdown.

Latin American country indices compared with risk

Definitions: Max loss: the worst possible investment period. Max drawdown: The maximum loss from a peak to a trough of a portfolio and volatility: A measure which describes the fluctuation of a fund's price over time

Source: Trustnet, as at 5.08.16

Because of the risks of regional Latin American funds some investment analysts suggest that you may be better getting your exposure via a broader fund. "We would recommend the vast majority of investors get their exposure through a global emerging markets fund where you're delegating calls to emerging markets managers who take a bigger picture view on where in the market to be invested," says Mr Hollands.

Alan Steel, chairman of Alan Steel Asset Management, agrees. "Latin America is an area that has been promising to burst out of its rollercoaster behaviour for as long as I can remember. I've had my fingers burned there too many times, so we rely on emerging markets managers to make the calls instead."

Even without a Latin America-specific fund you are likely to already have exposure to Latin America via a global emerging markets fund.

For example, of the nine closed-end funds with the largest exposure to Brazil, only three are dedicated Latin America funds. JPMorgan Emerging Markets Investment Trust (JMG) has 12 per cent exposure to this region, as does Templeton Emerging Markets (TEM), and JPMorgan Global Emerging Markets Income Trust (JEMI) has about 8.5 per cent of its assets invested here.

JPMorgan Emerging Markets also has a 5 per cent weighting to Mexico. Anthony Stern, an analyst at Stifel, says: "The fund has outperformed its benchmark in five out of the last six calendar years, and when it has underperformed, the underperformance has tended to be marginal. On a 13 per cent discount, we do not think the consistency of the good performance is recognised."

Investment Trusts with largest weightings to Brazil

Source: Association of Investment Companies (AIC)

Tilney Bestinvest lists Fidelity Emerging Markets (GB00B9SMK778) and Newton Global Emerging Markets (GB00BVRZK937) as its top emerging markets funds. Fidelity manager Nick Price is supported by a regoinal team which includes Alex Duffy, responsible for Latin American equities and the region currently accounts for over 10 per cent of the portfolio. Newton Global Emerging markets was launched in 2015 and just over 7 per cent of its assets are investd in Latin America.

Performance of Brazil and Latin America funds

Source: FE Analytics, as at 8.08.16