In hosting the 2014 FIFA World Cup and the 2016 Rio Olympic Games, Brazil has certainly guaranteed itself some headlines in the coming years.
Latin America continues to conjure up images of carnivals and beaches, but has also seen negative press in recent years; from Mexican drug cartels, to Argentina’s debt problems and rampant inflation. Meanwhile, in some Latin American countries we are now entering a period of transition, with Colombia becoming relatively stable while peace talks with the FARC are ongoing and Chávez’s death in Venezuela leading to questions as to the longevity of chavismo. Looking beyond the headlines, is there a case for investing in Brazil and the rest of Latin America?
Strong projected economic growth compared to Europe and the US, coupled with the so-called demographic bonus in economies with an expanding middle class and the ever-present commodity story, means Latin America should be an investment destination on everyone’s agenda.
As of April 2013, the International Monetary Fund expects Latin American and Caribbean nations to grow 3.4% for the year, with domestic demand remaining buoyant. However, in the case of Brazil it advised that supply constraints could hinder growth.
The working-age population of Latin America is expected to expand until 2045. In addition, of Latin America’s population the World Bank notes that 50 million people have worked their way up the social and income ladder in the past decade to become members of the middle class, an increase of over 50%. Almost one third of Latin American families are now considered to be middle class.
**Oil & gas**
Estimates of Brazil’s recently discovered offshore pre-salt reserves indicate a potential for 70 to 100 billion barrels of oil equivalent and expectations are exploration of the region will transform Brazil into one of the 10 largest oil producers in the world. Meanwhile, Venezuela, the home of the largest known oil reserves in the world (according to BP’s Statistical Review of World Energy), is seeking financing from foreign partners to reinvigorate its oil industry with, for example, the country’s state-owned oil producer PDVSA signing a $2bn financing agreement with Chevron to increase output at its Petroboscan oil joint venture.
Less commonly understood is that the Latin American shale gas opportunity is bigger than that of the US. Argentina and Brazil have substantial shale deposits, which the US Energy Information Administration estimates could provide 1,000 trillion cubic feet of gas, while Mexico holds some 681 trillion cubic feet. Chile and Bolivia also have substantial deposits. By comparison, the US, where the shale bonanza is being played out by investors, has 862 trillion cubic feet of technically recoverable shale gas resources.
However, while the shale gas story may appear to be a boon to the region, the Inter-American Development Bank has noted: “the myriad political and institutional obstacles faced by national governments mean that a shale gas revolution of the nature seen in the US remains a distant prospect.”
Longer-term investors may do well from these oil opportunities but caution should be maintained when investing in strategic natural resources in Latin America. Instead of the oil exploration and production companies, oil services could be a less risky way to invest as Brazil and other parts of the world see a surge in offshore drilling and other exploration activities.
**Agriculture**
Latin American farmland and forestry opportunities have seen an upsurge of interest of late from institutional investors, as the region represents an agricultural frontier. However, investors must carefully select the correct asset type to match this opportunity. Flexibility in the length of the lock-up in a private equity allocation should reflect the length of time that the underlying land, or in the case of forestry trees, will attain the best value. Also of note, international investors will not necessarily be legally allowed to own freehold farmland across the continent and listed farmland stocks have not always performed well. Brazilian listed agricultural farmland stocks including BrasilAgro and SLC Agricola have heavily underperformed the Bovespa, while since listing in New York on 28 January 2011 the Soros-backed Adecoagro, a South American agricultural company with operations in Argentina, Brazil and Uruguay, has lost over 32.18% to the end of April 2013, compared to the S&P 500’s gain of 29.1% in the same period.
**Brazil large caps v small**
Has Brazil, long the favoured Latin American investment destination for international money managers, lost some of its shine? In May, economists predicted in a Bloomberg survey that Brazil’s GDP would grow by only 2.98% this year. This would mark the third annual sub-3% growth in a row. The FT reported that: “disenchantment with Brazil took root last year when the government gave power generation companies an ultimatum to lower the prices they charged for electricity or risk losing their concessions when they expired.”
There is certainly no lack of funds flowing to and from Brazil. When Warren Buffett decided to buy Heinz, it was to Brazil’s 3G Capital that he chose as his partner for the USD 28bn offer.
However, over recent years there has been a divergence between the performance of larger and smaller companies. In 2012, for instance, the MV Brazil Small Cap Index outperformed the Bovespa by more than 23%, according to Bloomberg figures.
Can the blame for Bovespa underperformance be put at the hands of state-owned institutions such as Petrobras and Vale? It could be questioned as to whether they are run for the benefit of the government rather than private investors. Petrobras, with the heaviest debt burden of any oil major, has plans to invest USD 236.7bn over the next five years.
Regardless of where the blame lies for recent large-cap underperformance in Brazil, the result points to the need to actively differentiate between stocks, or even indices, to get the best result from an equity investment in Brazil.
There are many available active managers in the region; however, a non-Brazilian investor should check that local managers have sufficient liquidity in their non-domestic share class, as often local investors will be in a different share class which could consist of in excess of 90% of the fund’s assets under management.
**Peru, Colombia and Chile**
For international investors seeking access to the Latin America story, traditionally only Brazil and Mexico have provided enough liquidity and high enough market capitalisation to attract large allocations. However, many asset managers now believe there is enough opportunity available elsewhere in the region.
PineBridge Investments noted that Colombia, Peru and Chile have “managed to grow their economies by an impressive 5% CAGR, on average since 2002, and the IMF expects this trend to continue through 2017.” Based on average estimates in Bloomberg surveys of analysts, the Peruvian economy may grow by 6.2% this year, the most among major Latin American economies with the exception of Panama.
PineBridge added that: “What these countries did really well was save during the last commodity cycle when their terms of trade were at a superior level, allowing them to spend away counter-cyclically during weaker years. Much of this spending was directed, very wisely, toward infrastructure and other capital expenditure, such that investment following the 2008 financial crisis to GDP ratios actually increased in all three countries.”
For investors wishing to take advantage of these rapidly growing economies, the S&P Mercado Integrado Latino Americano (MILA) 40 Index, created in August 2011 and available as an ETF, is designed to provide exposure to the largest and most liquid stocks trading on the MILA platform, an integrated trading venture formed by the Chile, Colombia and Peru stock exchanges.
Andean Capital Management returned +19.43% net of fees in 2012 in Andean Capital Investments, Ltd., a fund investing primarily in the equity and fixed income of Colombia, Peru and Chile. They are advocates of the many positives to be found in this part of the region: Colombia’s inflation rate being in a stable range between 2%–4% and the orderly privatisation of the mining sector in Peru, in addition to Chile acting as an entry point for foreign investment from the Asia-Pacific region into Latin America while maintaining the lowest credit risk in Latin America as a result of economic stability, monetary discipline, and a strong political and fiscal environment.
