As credit markets adjusted to lower oil prices and potential US interest rate changes last year, Latin American debt began to feel the effects of waning investor interest.
“In the last 12 months, Latin America has been our biggest underweight in our emerging market hard-currency fund, and that strategy has worked pretty well,” says Steve Ellis, an emerging markets portfolio manager at Fidelity Worldwide Investment. “There are some pockets of value, but overall Latin America is not that attractive.”
| How the funds are ranked LatinFinance’s 2015 Investor Scorecards are based on fund return data from Lipper and Economatica. | ||
The fund managers that have been able to find those pockets of value are those that have stood out.
Returns have not been devastating — but nor have they been as sparkling as some years past. Fund managers in LatinFinance’s 2015 Debt Investor Scorecard notched up returns ranging from 3.4% to just over 7% in the 12 months to the end of March. The scorecard, based on performance data from Lipper, measures debt funds with at least a 28% allocation to LatAm at the cut-off date.
In recent months, many of the best-returning funds have piled into long-term paper from Latin American issuers, which have outperformed.
“Latin American assets have the longest duration of the JPMorgan CEMBI index, so they have the possibility to outperform the rest of the regions,” says Gonzalo Borja, head of emerging markets fixed income at Credit Suisse. The Swiss institution’s emerging market corporate bond fund ranked third in this year’s scorecard, returning 3.49% over the 12 months, and 6.31% over three years.
A similar strategy on the sovereign side has worked for Barclays Wealth and Investment Management, says Sabina Raza, a fund manager. The institution’s emerging market debt fund ranked second in the scorecard, after returning 6.3% over the 12 months to the end of March. Latin American sovereigns with long-dated bonds, such as Panama, Peru and Uruguay, are particular favorites for Raza.
“Preferred countries in the region are those where there are signs of major improvements in economic data, strong fundamentals, fiscal discipline and so forth. Examples being Jamaica, Honduras and Belize, as these countries continue to make progress on the economic front,” Raza tells LatinFinance.
Oil importers like the Dominican Republic, which sold a $1 billion 2025 bond yielding 5.5%, and a $1.5 billion 2045 yielding 6.85% in January, is another pick for Raza. The long-dated deal was “attractively priced”. Additionally, upside opportunity comes from the fact that the B1/B+/B+ rated country has potential to be upgraded.
Clear favorites
Among the region’s larger sovereigns, investors have two clear favorites: Colombia and Mexico. They have high hopes that structural reforms in both countries will increase economic growth over a medium-term horizon.
With its larger size, its proximity to the United States and the efforts by the government of Enrique Peña Nieto to open the energy and telecommunications sectors, Mexico is a particular favorite for bond investors.
“Our positioning in Latin America over the past year has generally been underweight, except Mexico which has started a process of reforms,” says Sergio Trigo Paz, BlackRock’s head of emerging market debt.
The manager’s BGF emerging markets bond fund returned an impressive 7.12% over the year to the end of March.
Investors’ appetite for Mexico has been underscored by the sovereign’s activity in the debt markets this year. In January it raised $2 billion in a bond deal that was close to four-times subscribed. And in April, it tapped ultra-long dated demand among European investors when it sold a 4% €1.5 billion 100-year bond.
“Mexico will benefit in the medium to long term from the reforms,” says Borja. “Growth is coming but not this year or next, typically it takes a little bit of time. At the same they are linked to the US so they will benefit from growth there.”
The enthusiasm on the country’s economic prospects has driven investors into the country’s top-rated corporate bonds, sharply tightening spreads. Now investors are taking a closer look at Mexico’s triple-B issuers: companies that offer solid credit metrics at better value, and which have scope for upgrade. Some managers are happy to dabble in high-yield bonds, too — although the low number of Mexican non-investment grade companies tapping the market limits activity here.
Some investors say they are taking a cautious approach toward debt from Chile and Peru because of the economies’ heavy dependence on mining exports. Colombia, despite the importance of oil revenues to its economy, has found favor, though.
As in Mexico, Colombia’s currency has depreciated against the dollar. That has cushioned the effects of the oil price slump for some parts of the economy. The Andean country has also found strong appetite in the new issues market from bond buyers: it raised $1.5 billion when it sold a 2045 bond in January. At just over 5%, the note boasted the lowest yield the sovereign has ever paid to borrow at such a long maturity.
A string of Colombian corporates and financial institutions followed soon after, also finding strong interest from investors.
Global forces
Despite the highlights, a number of issues are undermining the attractiveness of Latin American assets. As Chinese growth has slowed, from 10.4% in 2010 to the 7% estimated for this year, the country’s demand for minerals, grains and protein is also expanding more slowly. That has hit Latin America as a whole, and commodities exporters are particularly feeling the pinch.
“For many of the countries in the region, the fundamental deterioration accelerated in the second half of 2014 with a 50% oil price slump,” says BlackRock’s Trigo Paz. “The subsequent fall in fiscal revenues for the oil exporters was so sharp and fast that today in some countries policy makers are still trying to figure out what the national accounts look like.”
Other international factors, such as political instability in Ukraine, also kept emerging market bond buyers on their toes in 2014.
“The name of the game last year was two-fold. It was to be disciplined and cautious in Russia given some of the geo-political issues and sanctions,” says Sam Finkelstein head of macro strategies at Goldman Sachs asset management global fixed income team. “And, in the second half of the year, as a generalization, oil exporting countries or those very dependent on commodities underperformed.”
Yet, political instability in Eastern Europe was positive for Latin America. Goldman Sachs, for instance, replaced some of its exposure to Russia or commodity-intensive Latin American credits with an overweight in Dominican Republic and Honduras.
“Some of the bright spots have been Honduras, which after a presidential election got an IMF agreement,” says Finkelstein. “We started positioning in Honduras during more stressed periods. And, another country that actually benefits from lower energy prices is Dominican Republic, as well as a number of Caribbean countries.”
In Brazil, the wide-reaching implications of the Lava Jato investigation into corruption prevented any
company issuing bonds in late 2014 and the first months of 2015. At the center of the investigation, Petrobras has been most severely hit by investors worried about the implications of the scandal.
“Brazil is a challenging story,” says Finkelstein. “We dissected Petrobras, and the ability of the company to report and some of the companies that have business relations with Petrobras that are certainly under scrutiny. There was not enough insight, or enough risk premium, or enough clarity to start investing aggressively there.”
Yet, many investors have stayed loyal to the region’s largest bond issuer. Barclay’s chose to hold Petrobras debt after the company assured them that it would release financial results before the end of April, which it ultimately did.
Other Brazilian companies offer value, say some. That goes particularly for exporters, such as JBS, Marfrig or BRF, which stand to benefit from the weaker currency.
Fund managers have treated Venezuela and PDVSA assets with caution. Bond yields on both offer sparkling returns for those game to dabble. Many investors have avoided the sovereign and PDVSA. Yet, others have been lured by the yield on offer.
“Where we have exposure to PDVSA is at the short end of the curve, where you could arguably say that there is less risk,” Raza says.
And while the managers featuring in LatinFinance’s scorecard tend to focus on dollar-denominated bonds, some have ventured into local currency paper in their search for returns.
“An area that we are more comfortable in Brazil is local debt and is because the Central Bank has hiked rates and we are actually quite pleased with Joaquim Levy’s commitment to a fiscal reform and to improving Brazil’s fiscal accounts,” says Finkelstein. Uncertainty around when the US Federal Reserve will increase rates has dogged bond investors over the past year. That looks set to continue, as analysts push back their forecasts on when the long-discussed rates move will take place. In late April, some observers were predicting a move toward the end of the year.
Liquidity, exchange rates, commodity prices and growth forecasts for emerging markets will play a part in determining the overall market reaction to the event — whenever it might happen. Some investors are likely to redirect capital toward less risky assets in the US. Others say better growth there will spur a sunnier outlook across the world.
After years of discussion as to when and how the US will normalize monetary policy, though, the final event is unlikely to cause a dramatic repricing of Latin American bonds, says Finkelstein. If anything, the rate hike itself “may be something as a cleansing moment, as a cathartic moment and markets take it on a stride”, he says.
Differentiation rules
In the months ahead, political, social and economic issues in Latin America and the world will determine where bond investors can find value in the region. One theme, however, is clear: top investors are focusing their strategies on individual countries and borrowers, rather than treating the region as a single unit. The countries that cut their reliance on revenues from commodities and which show fiscal and monetary discipline will be the ones that most spark investor interest.
And of course, every rule has its exception. While fund managers indicate they will avoid Latin American credits tied to the commodity cycle, Ellis notes that “everything has a price”.
“If prices continue to worsen, valuations will get more and more attractive — then that would tempt us to become interested in the region. At the moment we don’t see an awful lot of value.” LF