WEALTH MANAGEMENT: THE HUNT FOR RETURN

With the end of cheap money and a plunge in bond and stock prices in 2022, wealth managers have had to search for returns. Of all the investments, Latin America has surprisingly fared better than most – but the strategy advice for the coming year won’t be the same. 

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In the middle of the COVID-19 pandemic, optimism began to take hold that the end of the lockdowns would usher in a 21st century equivalent of the Roaring Twenties, a period of booming economic prosperity in the wake of the 1918-20 Spanish flu. Those hopes were dashed in 2022. The Russian invasion of Ukraine, a slowdown in China and aggressive rate hikes from central banks struggling to contain inflation created an environment in which both bond and stocks yielded negative returns over the year.

Save for short sellers, few portfolios escaped unscathed.

Through all this, however, Latin America fared better than most regions. The S&P Latin America 40 provided a year-to-date return of 2.65% by early December 2022, compared with a drop of 24.5% for the S&P Asia 50 and 65.7% for the S&P/IFCI Europe index.

As investment strategists forecast continued volatility, sticky inflation and a possible global recession in 2023, LatinFinance looks at the key trends in the domestic wealth management market and asks whether Latin America can repeat the relative success in 2022.

EXPERIENCE COUNTS

When the US Federal Reserve increased rates by 25 basis points in March 2022, the outlook for Latin American markets looked grim.

“Typically, the start of a US rate hike cycle spells bad news for Latin America,” says Axel Christensen, Blackrock’s chief investment strategist for Latin America. “It’s often the entry point for a crisis.”

But there was no repeat of the 1994 Tequila Crisis, when rate hikes led to a sudden devaluation of the Mexican peso and spread contagion to Southern Cone currencies. This time, the Colombian peso plunged following the election of the country’s first left-wing president, Gustavo Petro, but the Mexican peso and the Brazilian real strengthened over 2022.

“In a strong dollar year, who would have thought the real and the Mexican peso would be amongst the stronger currencies?” says Christensen.

It helped that Latin America is largely disconnected from the Ukraine conflict and, in many cases, a net beneficiary of higher food and fuel prices. But more so, it was the early and aggressive stance of the region’s central banks, many of which began hiking interest rates in the first half of 2021, that was crucial for the region.

“The past experience of companies and governments meant they were often better prepared to deal with inflation than in the US or Europe, where they’re seeing the worst inflation in a lifetime,” says Christensen.

Edgardo Sternberg, a vice president at Loomis, Sayles & Company who manages the firm’s short-term emerging market bond fund, said he started exiting Russia in early 2022 in anticipation of sanctions rather than an invasion. He went overweight in Latin America. “It was a good place to be in, not only by default due to the problems in other emerging markets, but because they were ahead of most other central banks in fighting inflation,” he says.

GROWING DOMESTIC MARKETS

Latin American private banking grew steadily during the pandemic. In Brazil, the segment saw 5.2% growth over the first nine months of 2022, reaching BRL1.87 trillion ($370 billion). Thanks to digitalization, a new type of client is entering the market, according to John Ward, managing director at BNY Mellon’s Pershing.

“The Latin American wealth business has historically been a high-net-worth and ultra-high-net-worth private banking business model,” he says. “Now technology is enabling the banks to serve the mass affluent community in a more effective and efficient way. In Brazil, millions of new investors have entered the market.”

In the last five years, Ward says political, social and economic shifts in the region have accelerated the longstanding trend to shift the custody of assets to a US-domiciled entity.

Photo: Nur Cristiani

“The two main things we’re telling our clients are, firstly, the importance of going back to basics and reassessing the importance of fixed income in their portfolios and, secondly, the importance of diversification,” she says. “You wouldn’t believe how focused [clients] have been on thinking only about equities.”

With $180 billion under management, J.P. Morgan is the largest private bank in Latin America, and it began recommending that its clients add US 10-year T-bills to their portfolios once yields increased above 3.2%. Any client deliberating between short- and long-term bonds should go for the longer duration, says Cristiani.

It’s going back to basics in the sense that fixed income should act as an anchor to a portfolio.

Nur Cristiani

“It’s going back to basics in the sense that fixed income should act as an anchor to a portfolio,” she says. “We expect to go back to the negative correlation between equities and fixed income that was broken in 2022. That is our highest conviction call.”

CORPORATE BONDS

Fund managers and investment strategists are looking to implement a similar strategy in Latin America, with corporate bonds looking particularly attractive. Investors, they say, will have to get used to operating in a higher inflationary environment, meaning central banks are less likely to use monetary policy to protect jittery markets.

“Going forward, we’re less optimistic that central banks will step in to step in, no matter what,” says Christensen. “In this scenario corporate bonds become a lot more attractive. Our sweet spot is investment-grade bonds. I’d have to go 10 years into the past to find the same level of yield we’re getting today.”

After years of positive returns, Loomis’ short-term emerging corporate bond strategy turned negative in 2022, but a strong showing from its Latin American exposure helped it outperform most other portfolios.

“It’s a strategy that incurs less damage and gives you some income,” says Sternberg. “Right now, you’re getting pretty high yields of around 8% when most of the damage from the US Treasury curve has already been done and it’s often better than owning sovereign bonds which could deteriorate further [on political factors].”

A problem, however, is that the market for Latin American bonds has always been relatively illiquid and new issuers are likely to balk at paying yields in the range of 7% to 9%. In the meantime, other emerging markets could present more attractive options in the first half of 2023.

“I doubt we’ll increase our Latin America exposure next year,” says Sternberg. “There may be better opportunities elsewhere, particularly in India, which is growing strongly, and in certain parts of China, treading carefully around the property sector.”

THE PATH AHEAD

Even so, there are near- and longer-term reasons to be optimistic about Latin American markets.

Blackrock plans to start the year in emerging markets, but it expects the outlook could turn more positive toward the end of the year. Having started earlier, Latin American economies could hit the peak of the rate hike cycle earlier than developed countries, perhaps in mid-2023. The region’s exporters of copper, iron ore and food would also benefit from a revival of Chinese demand over the course of the year as Beijing eases COVID-19 restrictions.

Two important structural advantages in Latin America – strong demographics and a shift toward nearshoring US production – are starting to make their first significant impact on investors’ sentiment, and this could benefit Latin American economies in 2023.

The region could benefit from the geopolitical rewiring of the economy, as the US seeks to nearshore production and increase the security in the supply chain.

Axel Christensen

“While China may have already met its peak in terms of worker population, in Brazil, Mexico and Colombia the demographic trends are more favorable,” says Christensen. “And the region could benefit from the geopolitical rewiring of the economy, as the US seeks to nearshore production and increase the security in the supply chain.”

The biggest risk facing Brazil and a number of other local economies in 2023 is likely to be the expansion of the fiscal deficit.

However, Cristiani says that this has mostly been accounted for in market expectations.

“We’re not out of the woods yet, but for now we’re comfortable with the Brazilian government’s expansion on the deficit,” says Cristiani. “We believe that assets are well valued for that risk and that there are opportunities stemming from commodity price increases, the inflationary environment and the structural changes towards nearshoring. Latin America is a region that has all the right linkages to the growth drivers we are going to see in 2023.”

THE RETURN OF ACTIVE TRADING

While investors may differ in their tactics, they agree that the period of the great moderation, when clients could park their funds in passive investment vehicles and rest easy, has well and truly passed. In 2022, tactical funds, often with bold and unconventional investment theses, made their comeback, and further volatility is expected into 2023 and beyond. That means more frequent portfolio changes, according to Blackrock, and the development of contingency strategies.

“Traditionally we would look at the next year and have a base scenario with perhaps two alternative scenarios that could occur, but we wouldn’t develop those alternatives,” says Christensen. “Now we’ve connected them to the strategy we would implement in those conditions. We don’t want to start thinking about [that] once the conditions are in place, because that’s going to be too late.” LF