Ecuador defaulted on its debts in 1999 and had to restructure its obligations last year, forcing investors to accept a 40% cut in principal. Colombia lost its investment-grade rating in 1999 and Standard & Poor’s downgraded the country twice last year. Meanwhile in Peru, a cloud of corruption left by former President Alberto Fujimori hangs over the country as it prepares for elections in April.
Investors who bet on Ecuadorian
These events were sufficient to cause the Andean region’s already struggling capital markets to crash, driving away yet more investors as liquidity dried up. Daily trading on the Lima stock exchange in February averaged $7.3 million. In 1997, before several of Peru’s largest companies delisted their stocks, daily turnover averaged $26.7 million.
Although investors rarely admit to losses and love to trumpet their successes, some investors have certainly managed to turn these adverse market dynamics to their advantage. Van Eck Capital’s Emerging Market Global Opportunity Fund, with 70% of its Latin American holdings invested in the Andean region, was one of the best performing emerging market debt fund through 2000 since 1997, according to Tass Management, an investment research firm that tracks more than 2,500 hedge funds. Last year, Van Eck’s Opportunity Fund yielded a 13.4% return on its Latin American holdings.
Hans Humes, the fund’s manager, says he focuses on overlooked markets where fundamental economic conditions are improving, but where forced sellers are unnecessarily depressing prices. These conditions can present excellent opportunities to accumulate assets cheaply. For instance, at the beginning of last year, Ecuadorian bonds were trading at 20 cents to the dollar. They reached 35 cents when the country’s restructuring plan was announced in June, giving a 75% return.
Betting on a Restructuring
Jeffrey Clifford, proprietary trader at Standard Bank in London, said he made a 40% return in two months buying Ecuadorian bonds at the time of the restructuring. “I increased exposure, expecting a 25% yield. It was clear that the investors would have no choice but to go with it,” he says.
Van Eck’s strategy paid off during the turmoil in Peru. Political uncertainty at the end of last year was compounded when rumors of a coup leaked into the marketplace as Fujimori fled into exile. But the situation provided excellent buying opportunities in Peruvian debt, says Humes. Valentín Paniagua, the country’s interim president, caused further market turbulence when he threatened in November to suspend foreign debt service payments. However, Humes says, “We decided Peru was not going to restructure.”
Michael Ellis, another proprietary trader at Standard, says he took advantage of volatility in Colombia after a number of negative events, including the S&P downgrade and news of a referendum on the dissolution of Congress, caused a panic. The 2020 bond, issued in February 2000, lost nearly 25% of its value by early May. “We viewed that the market was oversold and picked up some paper near the lows,” Ellis says. “Colombia has a good repayment record and we felt that its debt service capacity was not as bad as the market was pricing in. We made about 10 points return, selling the bonds in the mid 80s about a month later.”
Even during relatively tranquil times, Andean assets are plagued by illiquidity and volatility. This is especially the case with locally traded stocks where a trade can cost up to 10 times the average cost of an emerging market trade, according to Salomon Smith Barney. Emily Aloja, portfolio manager of the Credit Suisse Latin American Equity Fund, the best-performing Latin American equity fund last year according to Standard & Poor’s, says the fund had virtually no exposure to the Andean region for the most of the year.
“The reasons were partly fundamental, but also technical. There was not enough liquidity,” she says. “Liquidity has improved, but only from terrible to bad and is still nowhere near enough to get most investors interested.”
Odds Stacked Against Stocks
Joaquim Nogueira, senior analyst at Banco Santander Central Hispano in London, says institutional investors interested in the Andean area have to contend with a dearth of large issues. “It is almost impossible for large investors, who would want to invest more than $1 million say, to invest in most stocks,” he says. An institutional investor with $100 million or more is unlikely to look at a company unless it can put invest around $10 million to work. “It wouldn’t be possible with most Andean stocks because of the small daily trade volumes and the effect it would have on the price,” says Nogueira. “Even if investors were looking for smaller stocks they are more likely to go for those in Brazil or Mexico which are more liquid.”
So it is hardly surprising that few funds dedicate much of their portfolio to Andean stocks. In fact, S&P tracks only two funds investing solely in Peru and Colombia, and none that specialize in Ecuadorian stocks. MSCI recorded negative returns of 46% and 32% for Colombian and Peruvian stock indices in 2000 respectively. “A number of unfortunate events, including El Niño, the emerging markets crisis of 1998 and then a succession of scandals throughout 2000, has caused the Peruvian stock market to fall by 60% since its heyday in 1997,” says Casper Romer, who heads the Foreign & Colonial Peruvian Investment Company.
Illiquid and Risky
For the time being at least, it seems investors are not yet ready for Andean stocks: a deadly combination of illiquidity and political risk has put off all but the most adventurous investors. Tim Love, who heads BSCH’s Latin American strategy team, suggests that equity investors should however keep an eye on the markets.
He takes a quantitative approach to equity weighting allocation and ranks countries by price-to-book value, beta, dividend, yield, size and trading volume. The results recommend being overweight in Colombia. Peru and Venezuela (the research team does not cover Ecuador). Based on these calculations, Love has heavily reduced his previous underweight rating to the small Andean countries, but still remains marginally underweight on the whole until the political environment improves.
In Peru, investor sentiment largely depends on the outcome of April’s presidential election. Meanwhile Colombian risk will probably hinge mainly on progress in peace talks with guerrilla groups. Finally, in Ecuador, investors will be closely watching the government’s progress on executing IMF-mandated reforms. LF
Venezuela: Hanging Tough
Venezuela has suffered considerable political uncertainty in the last several years yet the country’s capital markets have remained relatively resilient. Although Wall Street analysts have cited a range of reasons for their negative outlook on the country during the last year, its markets out-performed most others in Latin America. Venezuela’s bond market outperformed the EMBI+ in 2000 by 2% and its stock market, with a 16% increase, was the only one in Latin America to end the year with a positive return.
Jerome Booth, head of research for Ashmore Asset Management in London, says “Some countries, are proven poker players but Venezuela gets all the aces and does not always put them on the table. The country has the capacity to turn the economy around very rapidly with some fairly easy policy decisions. It is naturally wealthy, but has a history of mismanagement.”
Last year the country was dealt a particularly good hand. According to Booth, increased oil revenues and turmoil in neighboring countries also propped up the price of Venezuelan assets. Pablo Goldberg, Andean fixed income strategist at Merrill Lynch in New York says investors, who perceived Ecuador, Peru and Colombia as being too risky, used Venezuela as a sub-investment grade safe haven last year. “We were overweight in Venezuela last year even though we were not happy with macro fundamentals,” he says.
Oil was also an important factor behind Venezuela’s equity market rally – it rose 16% last year – but the main driving force was probably takeover speculation, says Rue Swabey, Andean equity analyst for BSCH in London. Oil prices helped the economy grow by an estimated 3% in 2000, but certain stocks underscored that growth, she says. Stock prices have been depressed and multinationals have been coming in and buying Venezuelan companies. Empresas Polar bought the food company Mavesa for $522.8 million in February.
Swabey agrees with most analysts that political risk will continue to scare investors away. James Upton, head of Latin American equity strategy at CSFB in New York, warns “Venezuela will be walking a fine line. The price of oil will probably stay at a decent enough level for them not to get into trouble, but they will also have to develop other parts of the economy.” Even so, Venezuela does have some good, well-priced companies. He says, “Take CANTV for example, it will probably do very well. It is well-run, has a sound business plan, and a good customer base. Valuation-wise it is also quite cheap.”
Gianfranco Bartozzi, Latin America economist at Lehman Brothers in New York, says there is cause for concern should oil revenues begin to fall. “Oil has been clouding the underlying macro imbalances. There are deepening structural flaws in the economy.”