Carnival time for Latin America fund

PUBLISHED : Tuesday, 21 February, 2006, 12:00am
UPDATED : Tuesday, 21 February, 2006, 12:00am

Phenomenal equity performances in the Brazilian and Mexican markets have generated phenomenal returns for Threadneedle

LATIN AMERICA HAS in the past 20 years become synonymous with crises. Social upheaval, political chaos and ruinous policies have conspired to level its economies, helped occasionally by events abroad, and its stock markets have often been among the world's most beaten up.

But those who dared to bet on the region when it was at its nadir in 2002 - the year Argentina defaulted on debts of US$81 billion and the anti-business figure of Luiz Inacio Lula da Silva rose to power in Brazil - have been well rewarded.

The force driving this reversal of fortunes is simple but compelling.

Jules Mort, manager of the Threadneedle Latin America Fund, said that ignoring the 'flash and bang' of Latin American politics and 'externalities', such as the United States interest rate cycle, emerging markets - and Latin America in particular - have been propelled by one major structural theme: anything China produces becomes cheap and anything China wants becomes expensive.

'With its prodigious output of commodities such as iron ore, copper, gold, oil, and soya beans, Latin America has clearly been on the right side of this dynamic,' Mr Mort said.

'If we look at the key Brazilian and Mexican markets, strong corporate earnings growth has been backed up by healthy trade surpluses and sensible economic policy. The result has been stellar equity performance.'

Mr Mort's Threadneedle Latin America Fund, which won the five-year trophy in the Latin America equity category of the SCMP Fund Manager of the Year 2005, generated a cumulative return of 247.2 per cent in the past three years.

But as grateful Latin America investors look back on three years of phenomenal returns, the question being raised is whether the rally can continue. The most visible obstacle to further market gains are the presidential elections that will be held in almost every major Latin American country this year.

'Seasoned Latin American investors will note that Latin equities rarely perform in an election year ... Some commentators have expressed concern that Latin America may be turning left, following the recent election of [Bolivian President Evo] Morales, a populist socialist to complement [Hugo] Chavez in Venezuela and [Nestor] Kirchner in Argentina.

'But to be sanguine, it must be stated that Latin equity performance is not made or broken in Bolivia,' he said.

Mr Mort was confident that the boat would remain steady through elections in the key financial centres of Brazil and Mexico, and that sensible economic policies will prevail, regardless of whether the elected party leaned to left or right.

Both countries accounted for about 85 per cent of market capitalisation of the Latin America benchmark index, and made up a 94 per cent weighting in the Threadneedle fund.

'Brazil, since the election of former trade unionist Luiz Inacio Lula da Silva in 2002, highlights this,' he said. 'Latin politics will certainly be a soap opera in 2006, and we can expect some volatility in equities. But this supportive economic orthodoxy should persist through the noise.'

Mr Mort said Latin American markets could brush off the present upward cycle in US interest rates, noting that the trend had been anticipated by investors and regional governments. He said a repeat of 1994, when US Federal Reserve interest rate rises sparked a meltdown of the Mexican peso in what is known as the tequila crisis, was unlikely.

'More domestic companies are paying off their dollar debt and increasing their local currency debt exposure as they gain confidence in their own economies and financial institutions,' he said.

'Latin governments have much more manageable debt burdens, and the dependency on dollars and US interest rates is far less than in the early 1990s.'

If Latin American economies are sturdier than before, their companies are stronger for having toughed out times of crisis and are set to generate strong earnings growth this year.

Interestingly, although election year could wreak havoc, it also favoured certain industries, Mr Mort said.

'Governments seeking re-election typically ramp up their infrastructure spend, while in Mexico, every candidate promises to build more low-cost homes than their opponent. This should be supportive for Cemex, Mexico's largest cement company, and Urbi, a homebuilder, both of which we hold in our portfolio,' he said.

'Candidates in Mexico spend hugely on political advertising and this, combined with the Soccer World Cup [Mexico has qualified], will provide strong support for the Mexican media conglomerate Televisa.'

Mr Mort and three other investment professionals run the Latin America portfolio, which contains 47 stocks. They use a 'bottom-up' investment approach based on regular contact with the senior management of the listed companies and exhaustive in-house research.

'Rather masochistically, we spend our lives modelling more than 90 companies in Latin America, producing detailed profit and loss, balance sheet and cash flow forecasts, all in US dollars,' Mr Mort said.

'We then compare all the companies within the sector, looking at three key areas to see where relative valuation is most attractive [valuation, earnings growth over the next two years and profitability].'

The team then aggregated its research into a sector and country valuation analysis. Sovereign debt risk is discounted in these country valuations to determine which countries were the most attractive.

Mr Mort said that in this way the team could also formulate a 'top-down' perspective.