By John Rumsey
Mexico’s stock market has been the darling of
investors this year. By early August its main index, the IPC,
had climbed over 10% since January. In contrast,
Brazil’s Bovespa had returned just 3.4% over the
For much of the past year, Latin American investment funds
have cut allocations to Brazil, and their average allocation to
the country has dipped below 60% for the first time since the
start of the crisis, according to Cameron Brandt, director of
research at fund flow company EPFR Global.
But a number of influential fund managers are now turning
bullish on Brazil, arguing that its markets offer good value
amid what some now believe are improving growth prospects.
Nick Robinson, head of Brazilian equities at Aberdeen Asset
Management in São Paulo, has reassessed his Latin
allocations and turned a Brazil fan. "Mexico is trading at a
40% premium to Brazil, which is a greater differential than for
some eight years," he says.
"Our Latin fund has long had a structural bias to Mexico.
That is no longer the case," he says. Over the past six months,
he has become overweight Brazil and underweight Mexico.
Robinson has $11 billion invested in Brazil.
Will Landers, managing director and senior Latin America
portfolio manager at Blackrock in New Jersey, says Brazil is
looking cheaper than either Mexico or the much smaller and more
illiquid Andean markets. "At the moment, you can buy Mexico at
some 15 times next year’s earnings, Chile for 16
times and Colombia for 14 times. That makes these markets look
at best fairly valued," he says.
Landers now dedicates almost 66% of his funds on average to
Brazil – as against a 59% benchmark. He believes
better company results will be the trigger for a re-rating of
the Brazilian market.
Antonio Miranda, co-chief investment officer of New
York-based Compass Group with $4.5 billion of assets under
management, says Mexico had been the more popular market
because of excellent macro policies, a cheap currency and an
improving US outlook. But at current levels, "Mexico is looking
a little expensive on broad valuations," he says. He is
revisiting his Mexican allocation and viewing Brazilian
small-cap stocks, and particularly financials, more
Marco Freire, vice-president and Brazilian fixed- income
chief investment officer at Franklin Templeton Investimentos
Brasil, now favors Brazil instead of Mexico and is also
trimming bond allocations in favor of equities. "Growth in
Brazil will rebound more quickly than most people think," he
"Conditions in the credit markets are better, and banks are
ready to increase loans again. This is a very different and a
more positive picture compared to 12 months ago. Freire helps
manage $2.5 billion of funds.
Brazil has other advantages over Mexico, say fund managers.
The country boasts a far greater and more diverse range of
listings, especially among smaller companies, where some have
been carving key niches in the economy. Improvements in
corporate governance have been more marked in Brazil too since
the introduction of the Novo Mercado in 2004.
Bond market caution
But bond markets are nevertheless signalling short-term
caution on Brazil: rates have come down to historic lows,
inflation is likely to stay at 5% or more for the next 18
months, and the improving economy could fuel higher inflation.
In July Mexico overtook Brazil in terms of fixed-income
allocations for global emerging market bond funds for the first
time in more than five years.
The average allocation to Brazil was 10.53% against 10.56%
for Mexico, according to EPFR Global’s Brandt.
This time last year, managers allocated over 2% more to Brazil
than to Mexico.
Multi-asset investor Franklin Templeton sees more value in
equities than Brazilian bonds for the moment. "We expect growth
to surprise on the upside, which is not a good environment for
bonds – but should help domestic cyclicals," says
Market volatility has led to a drop in interest from the
traditional markets of Japan and Asia in Brazilian
fixed-income, he says.
But the arguments in favor of Brazil over developed markets
are compelling, Freire says. "Five-year Brazilian government
bonds are yielding 9% while the gross debt ratio to GDP is 60%.
That is unusual to find today, and now that the currency has
weakened and there is less foreign exchange risk, it looks all
the more attractive," he says.
The US Federal Reserve has indicated it will maintain
overnight rates at or close to 0% through 2014 while rates are
decreasing in Europe and sovereign ratings are under pressure,
he points out.
Franklin Templeton is launching a new multi-asset fund
called Brazil Opportunities. This aims to capitalize on the
combination of Brazil’s relatively high rates and
the good prospects for the equity markets. Freire has been
marketing this in Asia: "The Japanese are willing to listen but
are not coming back yet. We are looking for a return of
interest in the future," he says.
The expected pick-up in growth in Brazil may knock
fixed-income markets with higher rates in the short term, but
the silver lining is that it will underpin a stock market
The timing and strength of a possible economic rebound,
however, is hotly debated.
Alexander Gorra, senior strategist and head of the
international platform at BNY Mellon in Rio de Janeiro, sees
GDP growth this year at 1.5% overall, but believes government
measures will help stoke a recovery that will ramp up growth to
4% or more next year.
Carlos de León, Latin America portfolio manager at
Allianz Global Investors, forecasts 2–2.5% GDP growth
this year, picking up in the second half and rising to a
minimum of 4% next year.
Freire is more bullish for this year: he thinks a recovery
is already well established and will surprise on the upside,
including next year. Whatever the timing, managers agree that
government policies will have a significant impact on growth.
Brazil’s central bank is likely to loosen monetary
policy further this year.
That monetary easing will be accompanied by further measures
to stimulate the economy, with the government working on a
whole range of measures, says de León. They are likely
to include new infrastructure developments, including more
private participation in road concessions, ports, and airports
as well as additional tax cuts on selected industries and a
reduction in the cost of energy, he says.
Freire believes the government will act on a number of
fronts and says that there is further scope for loosening
credit controls through, for example, a slower implementation
of Basel III.
Companies and valuations
Although fund managers are generally consistent in their
optimistic prognosis for the Brazilian equity market, there is
less agreement on which sectors are most attractive.
Freire and Gorra have been adding in financials. Stocks have
been hurt by government actions to reduce spreads charged to
customers on loans as well as higher non-performing loan (NPL)
levels. President Dilma Rousseff has pressured state-owned
banks to reduce charges and criticized charges levied by
Freire says lower interest rates and an improving economy
will continue to drive down worryingly high levels of NPLs. He
reckons there has already been an improvement over the past
couple of months, with a fall of 5.68% in consumer defaults and
late payments registered in July. The improving economy and
lower NPL rates will persuade private banks to expand their
consumer loan portfolios again.
Gorra has increased his allocations to financials as well.
He is overweight in the sector and expects nominal growth in
credit of 10% this year and 15% next. The valuations are
compelling: bank stocks are trading at historically low levels
of 8.5 times forward earnings with a 4.5% dividend yield, he
says. Moreover, the recent weak performance has made the major
banks focus on improving efficiency ratios, and their expenses
are growing less than inflation.
Miranda is focusing on small-cap stocks. He says they have
outperformed the broad indices and that, this year, small caps
are up by 5% while standard MSCI Brazil is down close to 6%.
"We love the diversity of the small-cap universe and the
quality of management teams," he says. The fund is looking at
sector consolidation opportunities in the space.
For Robinson, the heavily discounted commodities sector is
looking good value. A number of negative factors have blighted
key stocks. Both Petrobras and Vale have suffered from
heightened government intervention. This has included selecting
key managers and overseeing investment plans as well as
influencing the very capital structure in the case of
"It’s hard to say where Petrobras starts and
the government ends," says Robinson. Moreover, the uncertain
global economic outlook with falling Chinese demand for iron
ore has hit Vale hard.
These negatives have persuaded managers to dump Brazilian
commodity stocks, and they now look oversold, says Robinson.
"Petrobras and Vale are trading at levels that have not been
seen for the last 10 years, and Petrobras is looking
particularly good value," he says.
Petrobras shares have proven highly sensitive to good news
at these lows. They had a near 6% bounce on August 8, on the
back of the government announcing that gasoline prices in the
country could be increased this year.
Landers has maintained a large position in Vale too. He was
disappointed by weaker than expected second quarter numbers,
which he attributes to weak demand from China. Even so, at five
to six times earnings and a yield of 4%, the company looks
attractive, he agrees with Robinson.
Global economic uncertainty has dampened down the still
moribund IPO market, and few fund managers see any great
pick-up before the start of next year.
Aberdeen Asset Management has not participated in a primary
issue since the IPO of shoemaker Arezzo in February 2011. "The
quality of companies coming to market has not been high. We
feel that bankers have been opportunistic and are pushing
fairly young businesses, sometimes with more than one business
rolled together, just to get out an IPO," says Robinson.
Gorra says that while the quality of IPO candidates has
improved, demand is limited. In Brazil, the launch of the
much-awaited offering of bank BTG proved disappointing to
investors with shares falling some 25% initially and, although
there has been a recovery since June, shares are still down
some 5% from initial pricing levels.
Brazil is not alone in facing a tough market, he says,
pointing to the disastrous launch of Facebook this May.
"Anything of interest will get pushed out to 2013," he
predicts. Gorra says companies have an additional financing
option of tapping private equity money as firms such as KKR,
TPG, Blackstone, 3i and Carlyle increasingly focus on
De León says that although there have been some eight
possible launches presented in the last two months, very few
have made it to the market, and the IPO environment remains
If the IPO market continues to suggest uncertainty, what do
fund managers believe could derail the rosy scenario for
Brazilian stocks? A further deterioration in global conditions
remains the greatest fear. An increase in inflation is another
risk as the central bank adjusts to an improving economy and
seeks to maintain growth. The weaker value of the Brazilian
real could feed into higher consumer inflation as the economy
recuperates, says Freire.
Another dark cloud is meddling by the government in
state-owned companies and even whole sectors. There has been
much interference in companies and sectors under the Rousseff
government, says Friere. As a counterbalance he says that the
government is also acting in a positive way to stimulate
growth. Moves to cut taxes and reduce energy prices are a
positive for companies and the economy.
The Bovespa index has been climbing steadily of late and
major fund managers reckon that there is more to come. The
shift of reallocations to Brazil from Mexico is a trend firmly
in place, they say. LF