Conservative, cautious and bearish were the most common buzzwords used by Latin American portfolio managers to describe the investment environment last year. The deepening fiscal crisis in Argentina and the decline of technology stocks in developed markets stifled performance of both the equity and fixed-income markets in Latin America. Although lower interest rates in the US helped financial markets in the region, economic uncertainty there still darkened the mood in Latin America.
In LatinFinance’s fifth annual review of the best performing funds in the region – conducted in cooperation with Standard&Poor’s Micropal – total returns and the distribution of assets reflect the turbulence buffeting the global financial markets. With the exception of portfolio managers in Brazil, most balanced or asset allocation fund managers, whose funds allow both equity and debt holdings, chose to maximize their fixed-income exposure and reduce risk. Several funds previously classified by Micropal as equity allocation funds were regrouped as fixed-income funds due to the large shift in assets to fixed-income from equity.
Brazilian balanced and asset allocation funds generally held the maximum percentage allowed of equity in their portfolios. Brazil’s Bovespa stock exchange fell 17% last year, but individual or stocks such as Petrobras and Embraer outperformed the Bovespa.
Strong Economic Growth
Despite grim prospects in the local markets, 2000 was a strong year for economic growth in Latin America. According to the United Nation’s Economic Commission for Latin America and the Caribbean (ECLAC), the region’s economy grew 4%, compared with just 0.3% in 1999. Latin America resumed growth thanks to recovery in Brazil and sustained expansion in Mexico. Brazil’s GDP expanded by 4% and Mexico grew 7%. Only Uruguay registered negative economic growth in 2000 with a 1% decline in its GDP. The Dominican Republic was Latin America’s strongest growing economy at 8.5%. Argentina’s economy stagnated last year and registered zero growth.
High oil prices helped Latin American oil-producing countries. Mexico’s external public debt fell by $10 billion as it the retired $6 billion in Brady bonds and repaid $3 billion in outstanding debt owed to the International Monetary Fund. Venezuela’s GDP grew by 3.5% last year thanks to rising oil prices and strong government revenues. In fact, Venezuela alone caused Latin America’s aggregate trade deficit to fall to $13 billion last year from $19 billion in 1999. Venezuelan debt outperformed the Latin America market.Venezuela-specific funds yielded an average of 11.4%, compared to an average of 9.1% for Latin American funds.
Equity and debt investors were heavily invested in Brazil last year. The central bank lowered the Selic benchmark interest rate to 16.5%, giving financial markets a hefty push. State and federal governments privatized several banks and electric generators, bolstering the fiscal balance sheet. Brazil met the inflation target mandated by the IMF, bringing consumer prices down to 5.5% from 8.4% in 1999.
A Direct Investment Slowdown
Foreign direct investment to Latin America fell last year to $57.4 billion from $77 billion in 1999, due to a slowdown in Brazilian privatizations and declining investor confidence in Argentina, according to ECLAC. Argentina’s FDI tumbled to $5 billion from $22 billion in 1999. Chile’s FDI fell to negative $1.3 billion in 2000 from $4.7 billion in 1999 and outflows exceeded incoming capital. Brazil received more than half the foreign investment made in Latin America last year, capturing $30 billion, while Mexico received $13.5 billion.
Latin America’s 10 largest sovereign debt issues raised more than $25 billion, with Argentina leading the pack with $9 billion in bond issues, followed by Brazil with $6.9, and Mexico with $4.9 billion. The bulk of Latin America’s sovereign issues were launched in the first quarter or in July at an average yield of 11.5% with some yields approaching 13% by the end of the year according to ECLAC.
The following pages include data and analysis of our fund management review, which includes regional and country-specific funds in the equity, debt and asset allocation categories. Micropal calculated winners in each category for one-, three-, five-years, and where applicable, for the seven-year time periods ending December 31, 2000.
Latin American equity funds suffered a turbulent year in 2000 as technology stocks tumbled and global equity markets slumped. Telecommunications companies continued to play an important role in Latin America, although the sector did not dominate the fund industry as it did in 1999. Mexico and Brazil were the focus of regional equity funds as fears over Argentina’s economic troubles caused many investors to shy away from stocks there. Most equity funds have retained only small holdings in secondary markets such as Venezuela, Colombia and Chile.
“The biggest risk for international investors in Latin America is not political or economic instability, but investing in non-modernizing companies,” says Fernando Donayre, portfolio manager for the Zephyr Latin American Equity Fund, the top-ranking Latin American equity fund in the three-year performance category. “Neither is transparency in Latin America as good as in other countries. We have to work twice as hard to understand the accounting principals between each country.”
Roberto Maxit, a fund manager at Buenos Aires-based Copérnico Capital Partners, believes Latin American equity markets have abundant value but the market offers few timing opportunities to make profitable trades. By going long on local Telefónica stock and short on the company’s shares in Spain when the Spanish parent company purchased the remaining shares of Latin American subsidiaries – Copérnico was able to unlock additional value in local Telefónica stock. Unfortunately, such opportunities are rare as liquidity in Argentina has dried up. Without liquidity there are few opportunities to make profitable trades.
Copérnico’s Latin American Strategic Fund was the best performing one-year asset allocation fund last year with a return of 13.7%, compared to an average loss of 10.55% for the category. Copérnico prides itself in enforcing strict loss-limit rules. Some of the fund’s strong investment moves last year included buying Mavesa shares in Venezuela at low valuations and reselling them to the company at a 226% premium during a share repurchase program in August. Copérnico profited from Argentina’s economic problems by going short on Argentina 2002 bontes.
A Shortage of Shares
Fernando Tisné, portfolio manager at Moneda Asset Management in Santiago, manages two top-ranking Chilean equity funds. Tisné says one of the most pressing issues affecting Chilean equity investments is a shortage of shares. “Shares in Chile are closely held,” he says. “The volume for Chilean stock trades has been increasing abroad and decreasing in local markets. We have to wait for either pension funds or foreign investors to sell shares before they are available.”
Moneda’s Pionero Fund was the top-ranked fund in the Chilean equity category for the three- and five-year periods. Incorporated in Bermuda, the fund is aimed at foreign investors wanting to invest in Chilean small- and mid-cap companies with a capitalization under $500 million. The Moneda Fund, incorporated in Chile, offers the same investment opportunities as the Pionero fund for local investors, primarily the local pension funds.
Moneda’s largest holdings include Saesa, the electrical distribution company, Cristales, a holding company involved in glass production, media, and wine, and Enaex, an explosives manufacturer. Small-cap companies represented over 85% of Moneda’s holdings.
“In 2000 we were bullish at the beginning of the year, particularly in the prospect for recovery in the Chilean economy,” says Tisné. “Nevertheless, as time passed we noted the economy was moving into a recessive cycle on internal demand. It was a tough year though, we tried to move away from the consumption sector to focus on new areas such as export-oriented companies.”
The Zephyr Latin American Fund, was the highest-earning Latin American equity fund in the three-year category with a return of 20.97%, compared to the average loss of 19.97%. The fund holds 59.3% of its $28.5 million assets in Mexico. Fernando Donayre, Zephyr’s fund manager based in Mexico City, believes consumer goods companies in Mexico such as Femsa, Kimberly-Clark and Organización Soriana, the retail chain, offer the highest-possible returns compared to their low valuations. In Brazil, Donayre is heavily weighted in Embraer, which represents 24% of the total portfolio.
The Compass Appreciation Fund, based in New York, was the best performing Latin American asset allocation fund in the three-year category for the second year in a row. It offers a mix of equity and fixed income investments. “We started the year with more equity than fixed income investments but as the year went one we placed more emphasis on fixed income,” says Juan Bosch, the fund’s portfolio manager. By the end of last year, the Compass fund was 46.6% invested in Brazil and 48.6% in debt instruments.
Bosch says the region’s high-risk profile made it especially vulnerable to Nasdaq’s crash. Although there is little similarity in the respective composition of the indices, Nasdaq-listed companies and Latin American stocks share similar risk profiles.
Selective Brazilian Opportunities
The Opportunity Brazil Value Fund took the top-ranking position for equity funds in Brazil while the Opportunity Brazil Balanced Fund took the top prize for asset allocation in Brazil in the one-, three-, five-, and seven-year categories. Despite the 17% decline in Brazil’s stock market last year, fund managers at Opportunity remain optimistic about the prospect for profitable equity investments.The Opportunity Balanced Fund, an asset allocation portfolio, maintained the highest-possible equity holding allowed by the fund’s mandate.
“[Last year] was very good for Brazilian macroeconomics,” says Felipe Padua, a fund manager in Opportunity’s Rio de Janeiro office. “Inflation was down, there was a decent trade balance and interest rates fell. The equity markets however, performed poorly although some individual stocks performed well and offered good opportunities for equity investments, such as Petrobras.”
Padua says that at the beginning of last year the company was bullish on Brazil, but the performance of the US and global stock markets pulled down the Brazilian equity market’s performance. “The fixed-line telephone companies did well although cellular-phone providers continued to suffer from high valuations and remained unattractive. We were also underweight on utilities,” says Padua.
Stock in Petrobras on the other hand was cheap at the beginning of the year and the company’s new management team promised to bring a more market-oriented perspective and better value to the company. Padua says this was a profitable stock pick last year. Usiminas, the steel company, was also a favored stock pick for the various Opportunity funds.
Marian Poirer, fund manager at Paribas Asset Management in Paris took the top-ranking spot in both the three- and five-year categories for equity in Mexico with the Paribas EM Mexico Fund. The Paribas EM Argentina Fund was top-ranking in the Argentina Equity category for the three- and five-year periods.
Fund managers invested in Latin American fixed income markets saw relatively modest appreciation in their holdings. The average return for Venezuelan fixed income funds tracked by Standard&Poors’ Micropal was 11.4%. Mexican debt funds registered an average annual return of 11% last year and Brazilian funds posted an 8.47% return. General fixed income Latin American funds averaged returns of 9.05% for the year.Returns on Latin debt funds last year were lower than in 1999 with most fund managers remaining seriously underweight on Argentine paper throughout the year.
The ABN AMRO Latin American Bond Fund placed first in the one-year general Latin American fixed income category. However, in January 2000 it had just $19.4 million under management, down from $80 million prior to the emerging market crises in 1998. The fund still attracts foreign investors to Latin America and approached $23 million at the end of 2000.
“We mimic the performance of global emerging market funds by linking the asset management of all ABN AMRO offices in the region to get more input – that’s our top-down approach,” says Rafael Kassin, fund manager for ABN AMRO Asset Management in London. Kassin remained overweight on Brazil, Ecuador and Venezuela. The three countries represent almost 90% of the Latin American Bond Fund’s asset distribution. The majority of the portfolio’s assets are long-term investments with maturities of more than 10 years.
“We had a contrarian view on Venezuela and didn’t expect oil prices to stabilize,” says Kassin. “Our fund is uncommonly high on Venezuelan debt compared to comparable funds, due mostly to the political situation to which other fund managers are risk-adverse.” Kassin says there are risks in Venezuela but “Chávez is trying to play the oil game – he can’t survive without it. If you can bypass the debt dynamics, Venezuela has a lot of money to buy back debt.”
In Brazil, the Sul América Fund managed by Sul América Asset Management, took the top prize for one-year performance for fixed income in Brazil. The fund allocates its proceeds to foreign debt securities such as Brady bonds, global bonds and corporate issues in Brazil. At the end of last year, the Sul América Fund consisted of 63.48% in global bonds, 17.58% cash, 16.96% in C-bonds and 1.98% in euro-denominated debt.
Brazilian Paper Stayed Strong
Despite concern over Argentina and later Turkey, the price of Brazilian foreign debt remained competitive last year due to a widely held perception that the Federal Reserve would lower US interest rates. This, plus a decline in domestic inflation allowed the Brazilian central bank to lower its Selic rate, which further improved international perception of Brazilian paper.
Luis Eduardo Pinho, fund manager of the Sul América Fund, says that at the beginning of last year Sul América was optimistic on Brazil but changed its views in mid-March with the problems with Nasdaq and rising concern over Argentina. Concern eased in July after former Argentine Economy Minister José Luis Machinea’s proposed economic reforms, but the mood had again changed by the end of the year, Pinho says. “We remained flat on Argentina and reduced risk in our portfolio,” he says. “Since this is a leveraged fund, liquidity is an important issue. Therefore we have concentrated our positions on sovereign rather than corporate debt. As far as duration is concerned, the fund does not have assets longer than five-and-a-half years.” Pinho remains concerned over Argentina and a slowdown in the US economy, and has lowered his target return to 12% for the year.
The Opportunity Fixed-Income Fund was the highest-ranking fund in the seven-year performance category. Felipe Padua, the fund’s manager, concentrated efforts in dollar-denominated short-term Brazilian sovereign debt with average durations of one year. “It was a good year because inflation was down and interest rates were lowered,” says Padua.
Padua says some foreign investors are beginning to avoid Brazil, wary of growing political risk with the approach of presidential elections next year. Short-term debt maturing before the October 2002 elections trades better than longer-dated debt. Padua says that the combination of fiscal adjustment and inflation-targeting monetary policies have contributed to the country’s appeal in the past year. However, there is no guarantee that the next government will sustain these policies.
However Padua says that the biggest risk for Brazil isn’t the election, but the situation in Argentina. He believes Argentina’s fiscal straits worsen by the day because the country is running out of resources to fix its problems. But Padua also says Brazil is stronger now and will recover faster than during previous crises.
Aldo Roldán, fund manager for Merrill Lynch Asset Management, swept the Mexican fixed income category for the one-, three-, five-, and seven-year periods. Roldán says last year was a bearish year for Mexican peso investors.
“There were two threats to the Mexican peso in 2000, the first being the presidential election and the second the transition period,” says Roldán. “Everyone was expecting high volatility in the exchange rate. There was a healthy concern that this could happen but we held our conviction to the peso.”
Roldán believes that the threat of a US recession could affect Mexican debt but that the country could continue growing despite currency weakness. “We’re going to see a buffer go up and we can take comfort that Mexico’s floating exchange rate will make any necessary adjustments,” he says. “We didn’t have that comfort during the last US recession that affected Mexico. Investing in Mexican fixed income is a no-brainer. Interest rates are consistently between 15% and 16%. Mexico borders the world’s largest market and exports to the United States continue to climb.”
The Legg Mason Global Mexico Premium Fund managed by Daniel de Laborde, director of Yturbe, Laborde y Asociados in Mexico City, is the second-ranking fund for a Mexican fixed income fund. The fund’s strategy is to provide aggressive, competitive bidding on premium government paper to generate returns above the Mexican 28-day Cetes benchmark.
The Legg Mason fund closed last year with $11.1 million in total net assets and was 12.7% invested in repos and a series of Mexican Cetes. The average maturity for paper in the asset portfolio was 36 days in December and the fund held no assets with maturities over one year.
Three years ago, the Bancomer BBV-MCRE fund invested more than 98% of its assets in equity, but negative market perceptions forced it to adopt a more conservative approach and it shifted to debt instruments. Mexican law allows all funds with equity investments of at least 10% to classify themselves at equity funds.
Sticking to High Grade
Enrique Camilli Desentis and Jorge Sigg Calderón, based in Mexico City, manage the BBV-Mexico Crecimiento Fund, which holds both fixed income and equity investments. Desentis says the fund only invests in the highest-grade sovereign paper and equities. Telmex (3.8%) is the largest equity holding in the fund, followed by Walmex (2.2%), Banacci (2.2%) and Cemex (1.6%).
“In 2000, the fund was especially conservative and its selection of paper was conducted through a fundamental analysis and short-term and medium-term performance expectations through beta strategies and volatility control to optimize profitability,” says Desentis.
The Toronto Trust – Argentina Fund, managed by Friedberg Commodity Management in Toronto, shifted its investment allocation from equity to fixed-income in Argentina due to the country’s lack of liquidity. Because Toronto Trust is a balanced fund, the managers have the option of reverting to fixed-income investments when equity markets do not appear profitable, as was the case in Argentina throughout 2000. The fund managed to generate positive returns when the performance of funds in the same category averaged -23.5% for one year, -38.44% for three years, and -16.2% for five years.
“In Argentina there’s a lack of liquid assets and companies are not focused and very [diversified],” says Albert Friedberg, portfolio manager of the Toronto Trust. “In 2000, we invested 100% in fixed income because we saw no profitable opportunities in the equity market.”
Investment fund managers expect large capital inflows this year to concentrate in the region’s larger equity markets, namely Mexico and Brazil. Fund managers expect less interest in the region’s smaller and weaker economies, such as Colombia, Peru and Uruguay due in large part to decreasing liquidity.
Fernando Donayre, portfolio manager of the Zephyr Latin America Equity Fund, believes 2001 presents a strong opportunity for emerging market investors to re-enter Latin American markets. “People began pulling money out of Latin America after the S&P 500 began increasing in value and there was less need for diversification after the 1998 crisis,” he says. “The next decrease in portfolio diversification came from the rise in technology stocks. Now with the fall in US stocks markets and technology assets, there’s a new argument for diversification and investors should once again look at Latin America.”
In Chile, fund managers expect to continue emphasizing small- and medium-cap companies while avoiding larger companies. Fernando Tisné, of Moneda Asset Management in Santiago says, “We’re not as bullish on the Chilean economy as a whole in 2001. We have seen companies make big gains in productivity and fixed costs by reducing work forces but in the past three years, the Chilean peso has devaluated heavily and dollar-exposed companies suffered. We’re also expecting a fall in interest rates in 2001.”
Whither the US?
At Copérnico Capital Partners in Argentina, fund managers expect Mexico to be vulnerable to the slowing US economy and Brazil to experience an overheating economy. They anticipate slow economic recovery in Argentina and continued political uncertainty in Venezuela.
Portfolio managers have mixed feelings about the effects of a US recession. Some believe a downturn would help shift investor interest from US securities into emerging markets, and particularly Latin America-focused funds. Others are concerned over a recession’s effect on exports, particularly in Mexico where 80% of the country’s exports go to the US.
“In 2001, I expect Latin American equities to outperform those from developed markets,” says Juan Bosch of Compass Asset Management. “Latin American fundamentals should begin gathering strength as regional inflation continues to trend down and economic growth will outpace that of developed countries. We should see a renewed interest in Latin America as the persistent attraction to new economy stocks in the last few years takes a pause.”
In Argentina, Albert Friedberg, of the Toronto Trust Argentine fund, says, “We remain concerned about the low liquidity in Argentine equity markets. The problem in Argentina is that there are small issues, although those sectors closely involved with energy may be the first to improve.”
One investment issue in which portfolio managers hope to see progress is the issue of minority shareholder rights and corporate governance reform. Chile has modernized financial market legislation, but reform of corporate governance laws in Brazil is bogged down in Congress.
Pressure to alter governance rules may come from Latin America’s largest-single investors, the pension funds. Zephyr’s Donayre believes that once local investors begin voicing their concerns about the lack of minority shareholder rights regulators will be forced to act. In Latin American politics, local players carry greater weight than foreign investors who are still often viewed with suspicion and distrust.
Asset allocation funds are those invested in equity, fixed income, and money market securities but typically have no more than 60% in any one asset class in a specific country or region. General Latin America funds must be at least 70% invested in the region and country-specific funds must be at least 70% invested in that country. Equity funds must be at least 70% invested in equity or related instruments, while fixed income funds must be at least 70% invested in debt. For example, an equity Argentina fund that falls below the 70% required equity investment is reclassified as asset allocation or fixed income fund if the debt investment is over 70%.
For periods of three or more years, an annualized Sharpe Ratio is calculated (annual return, less the risk-free rate, over the annualized standard deviation). For the risk-free rate – the level of the return on a “risk-free” investment – we used the annualized return on a 3-month US Treasury Bill over the relative period. The exception to this methodology is calculating winners in the one-year period. For these results, we rely simply on absolute return with dividends and capital gains reinvested. Any fund that did not respond to requests for information with the required time was excluded from the survey.