By Katie Llanos-Small
At the start of the year, few international portfolio
managers would have named Petrobras their favorite stock. The
oil firm's weak equity performance had for many months weighed
down portfolios and fund managers had resorted to
underweighting its shares.
But in single a day in early March, news of a diesel price
increase and new oil finds pushed its share price up 15%. The
underweights were left out in the cold.
Petrobras's sudden reversal of fortune is unlikely to impact
the underlying trend in equity investing in Latin America,
where in recent years large cap stocks have largely fallen from
favor. Investors have instead flocked to consumer industries,
favoring them to metals, mining and oil, on the promise of
Latin America's burgeoning middle class.
Yet as Petrobras shows, there are still returns to be found
- even among industrial giants, Brazilian corporates, and
non-consumer sectors - but only when stocks become cheap enough
to buy again. A range of fund managers interviewed by
LatinFinance say they are now grappling with identifying
precisely that point.
Dean Newman, manager of Invesco Perpetual's $890 million
Latin America Fund, which ranks fourth in this year's
scorecard, says that in Brazil, there is a contrast between the
"mega cap" stocks such as Petrobras and Vale; banks, which have
performed poorly in recent years, but where the valuations look
cheap; and domestic companies, which outperformed, but where
the valuations are no longer cheap.
"It's going to be a big call for all of us investing in
Latin America," he says. "We are in a bit of the transition
towards putting money into those bigger companies. They look
Managers are quick to rattle off their concerns about
Brazil. These include: requirements for locally produced inputs
in industry; taxes; exchange rate uncertainty; low growth; and
Adam Kutas, portfolio manager at Fidelity, says his
skepticism on Brazil dates back to late 2010: when the country
was named host of the 2016 Olympics, valuations leapt "off the
charts" for a number of companies.
"I was already feeling uncomfortable regarding earnings
expectations," he says.
"That was the first time I could create a bear case on
Brazil, having been visiting the country since 2000."
The fund lightened up on Brazil, focusing instead on Chilean
and Mexican stocks. "Last year the big risk that emerged was
political risk in various sectors. It manifested itself more
significantly than expected," says Kutas. "Valuations now are
better, but the fundamentals are still mixed at best. Brazil is
still a country in transition."
Despite their concerns, the best performing funds in
LatinFinance's 2013 equity investor scorecard still have heavy
allocations to Brazil. As the largest market by a long way,
investors need plenty of conviction for any other country to
dominate their portfolio.
But the allocations go beyond simply falling in line with
the index. The country's low growth and lackluster indicators
may offer a potential entry point. Christopher Palmer, director
of global emerging markets at Henderson, says that while
"Brazil is a problem" it is "also probably a buy, because of
the depth of the problems".
"Sometimes it's best to invest when things looking a bit
uncertain," he says, adding that the administration is now
demonstrating its commitment to addresses underlying economic
problems. "The best time to buy other global emerging markets
was when people weren't so sure about things: when Colombia was
emerging from the FARC problems; Peru, when president Humala
was elected. People had a lot of concerns, but we've moved on
Fidelity's Kutas also looks for opportunities to pick up
stocks when others take fright. His fund holds stocks for
around five years on average - trading costs can be high and
liquidity can be tough in these markets, he says. That
contrasts with the strategy of many crossover investors who
play for quick growth rather than long-term value. The
volatility those accounts create can present opportunities, he
"I try to be cognizant of how fundamentals and valuations
look relative to global peers and developed markets," says
Kutas. "When these investors exit they're very price
Worries that surfaced about Brazilian utility companies in
2012 are one example. "That can create a lot of downside
momentum, but if you know the companies and the fundamentals,
you can pick up stocks at fire sale prices."
Mexico sits at the other end of the spectrum. The best
performing equity fund managers are upbeat about the country's
"One can have a high degree of confidence that Mexico will
do the right thing from an orthodox fund manager perspective,"
says Invesco's Newman. "If they have to take a tough decision,
they will take it."
Still, only a fifth of his fund is invested in Mexican
stocks - compared to nearly two thirds in Brazilian ones. That
is an underweight of the MSCI benchmark, and reflects relative
valuations. "Some [Mexican] stocks are a bit expensive - you
have to focus hard on stock selection," says Newman. "In
Brazil, the aggregate market is cheap. It's generally unloved
by international investors and sentiment is poor. That creates
an opportunity. If valuations are cheap and sentiment negative,
it doesn't take too much improvement in the news to move things
the other way."
A rapidly expanding middle class has put Latin America's
consumer sectors in favor. Henderson's Gartmore Latin America
fund was overweight consumer staples at the end of February.
Brazilian banks Bradesco and Itaú Unibanco accounted for
over 12% of the fund's allocation, while Pão de
Açúcar, América Móvil, Ambev and
Coca-Cola FEMSA were also among its 10 largest
"Right now our favorite sectors in LatAm revolve around the
consumer," says Palmer, who manages the $1 billion fund.
"So that would be straight sector - we're overweight the
consumer. We had been adding more money to financials in recent
months and mainly in property related areas - real estate
developers and real estate investment companies, like REITS or
companies with REIT-like characteristics."
That strategy is one that others echo. Henderson's fund is
underweight materials. Others are similarly bearish. JPMorgan's
Latin America fund had a 9.6% allocation to materials at the
end of February, in contrast to a 26% allocation to consumer
staples and discretionaries, and 31% in financials.
JPMorgan allocates its Latin America fund according to
expectations on how the region will look over the next five to
10 years. In 2010, the firm took a view that China's structural
slowdown would have a long-term impact on Latin American
economies, says portfolio manager Luis Carrillo. Heavy demand
for natural resources from Latin America would wane as the
Asian nation rebalanced its economy.
"As that transition happens we expect less consumption of
raw materials," says Carrillo.
In the past, the Latin American equity index has resembled
the commodities index. "That's not necessarily the best way to
have exposure to the Latin America of the future," says
Today, rising domestic consumption is buoying GDP growth
across the region. That is likely to push commodities out of
the picture as the main economic driver - and alter the make-up
of the index.
"Smaller companies not even part of the index today will
become part of the index in the future," says Carrillo. "The
bigger components today, the commodities firms, will be a
smaller percentage the index in the future. We expect the index
in the future to resemble more the GDP make-up today."
But not everyone loves LatAm's consumer story. Fidelity's
Kutas worries that consumption in Brazil is driven by credit,
and adding to inflation.
Although Fidelity's Latin America fund is overweight
consumer staples and financials, it allocates just 2.79% to
consumer discretionary companies. That's a sharp underweight of
the 5.34% allocation in the fund's benchmark, the MSCI EM Latin
"The average guy walking down the street in São Paulo
has never seen these rates before," says Kutas. "The ability to
borrow is a lot better than it has been. But that can also put
pressure on food and oil prices, which are very important for
the average consumer. Pressure on the consumer from inflation
is not reflected in many of the consumer discretionary stocks
Beyond sector favorites and geographical bias, the top
managers say they prefer to focus on the performance potential
of individual companies. That involves examining the company's
strategy and its management team.
Nicholas Morse, who manages Schroders' Latin America Equity
Investment fund, says he looks for management teams that
understand their industry well enough to anticipate upcoming
"We try to find companies that are well run and that are
winners in their sectors," says Morse. "If you find a well-run
company that can continue to add value and think cleverly
within the sector, you can do well."
The detailed, bottom-up approach has the fund weighted
differently to some other top performers. It was underweight
consumer staples, and marginally overweight materials, at the
end of February, for example. But it has driven impressive
returns: averaging 3.4% annually over the past three years, the
fund is fifth in LatinFinance's scorecard.
"A lot of the companies we have are domestically orientated
and have higher than average return on capital employed," says
"They might well trade at a premium to the market, but they
have normally significantly better earnings growth than the
peers in their sectors."
Realistic on returns
As portfolio managers jostle for next great performing Latin
stock - scrutinizing spreadsheets and investigating on the
ground - alarm bells are being sounded on investor
JPMorgan's Carrillo says that as economies mature, the
risk-reward balance will change. "I don't think that the Latin
America of the future is anything at all like the Latin America
of the past," he says.
"The risk has changed a lot. In 2000, we had basically one
country that was investment grade. Now every country is
investment grade. The level of risk has changed, so it's
difficult to get the same valuations of the 1990s. Some are
looking at Latin America with expectation of 30%, 40% [annual]
performance. We see something closer to 10%."
Henderson's Palmer is similarly cautious on the scope for
outsized returns. It is "incredibly tough" to beat the
benchmark over the longer term, he warns.
"It's interesting to see how many managers feel that they
have cracked the code and can take big benchmark-related risks
and somehow feel that they're going to outwit the benchmark,"
he says. "As time has shown us, it's really tough."