Trying to see through the fog of the COVID-19 pandemic for equity investors is likely just as effective as trying to successfully predict where equity markets will close out one of the most historic years on record, and there are six more turbulent months to go.
Latin American equity prices have ricochet off their late March lows and yet benchmark indexes are still down stomach churning levels for the year, indicative of the ferocious flight-to-safety sell-off that slammed the region. At one point the MSCI EM Latin America equity index lost more than half its value, only to see a rally boost it to a still eye-watering negative 35% in late June.
“I think investors need to be increasingly attuned to who they think is the best placed to recover, meaning to have the best place to recover with both speed and magnitude,” said Edward Evans, senior portfolio manager at London-based Ashmore Investment Management. “The good news is there is a huge opportunity set,” Evans said, adding: “I think investors overall haven’t had a better time to deploy capital to emerging markets since the previous severe market dislocation in 2016,” even as the overall macroeconomic picture is going from “horrible to less bad.”
A massive and unprecedented policy response to the crisis is underpinning the rapid rebound, but Evans does not believe the recovery will lift all boats uniformly.
Instead, the crisis has brought about a shift in the Latin American portion of the firm’s Emerging Markets Active strategy portfolio, which is down roughly 14.5 percent year-to-date. Last year Evans said the fund beat the MSCI Emerging Markets index by 8.2%.
The Latin American exposure in the portfolio, from the start of the year, has seen a 5% overweight in Brazil reduced to about 3%. At the end of 2019 there was 3.5% overweight for Mexico, but now it is only a marginal overweight. In contrast, a 2 percent overweight for Peru at the start of 2020 has increased to 4%, Evans said. The current overall exposure to Latin America is approximately 17% of the portfolio.
Evans says the greatest comfort level within Latin American equity is in the mining sector, and generally sectors that will export to other emerging markets outside of the region that have already been through the COVID-19 crisis.
“First and foremost, there’s a demand recovery from certain areas of the world which were first into the COVID situation and apparently sequentially among the first out of it. Of course, in part what I am talking about here is China. And so it is an ability, a mechanism for playing that recovery story through China in the best possible way,” he said.
Exposure in Latin America is turning toward mining while exiting from banking, especially Brazilian banks, he said.
“So we’ve been generally rotating, reducing to zero the Brazilian banking exposure, and as I said rotating up more so into these mining names as we have that increased visibility,” he said.
The exposure to Brazil at the end of last year was higher because of the government’s pension reforms and anchored inflation expectations. “It has a lot going for it from a low base. But of course COVID and energy has gotten in the way of that… the policy response hasn’t been great, to put it mildly” he said referring the government’s actions to fight the pandemic. Brazil’s infection and death rates are still climbing, having never slowed even when the rest of the world seemed to be gaining control. Now with infection breakout spots, the slowdown and reversals elsewhere look tenuous.
As for the region’s miners, they remain “some of the lowest cost producers,” he said. “They are still profitable even at sort of depressed levels. So consequently, they can continue to grow out their earnings and be profitable, which I think would be recognized by the markets,” he said.
Indeed, even as commodity prices have dropped and crimped earnings for all major companies, Fitch Ratings recently said the credit positions of major global miners, including Brazilian iron ore miner Vale SA, are supported by strong cost positions, conservative balance sheets “and initial measures taken by their management teams to preserve cash flow, including reduced capex and dividends.” Other majors are more diversified, though, compared to Vale, which is more concentrated in iron ore.
Evan’s observes that the downturn shows emerging market investors, in their dash for cash, have taken what they could rather than what they wanted to take out when they made their selling choices. Essentially they targeted highly liquid names, which reminded him of the last time there was such a market rout at the tail end of 2015 into 2016. At that time there was a lag at the start of 2016 with an underperformance of the benchmark MSCI Emerging Market index.
“We were up over 10 percent that year (2016) in relative terms. So it is actually, we hope, that the same applies this year, this time around.”