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
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 cheap."
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 from
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 says.
"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
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 economic fundamentals.
"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
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,"
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 America.
"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
"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
"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
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."