Originally written by David Kimberley on What Investment
Investors in Latin America had a tough time in 2021. Whereas governments in most developed economies propped up equities markets with massive economic stimulus over the course of the pandemic, support was less forthcoming in Brazil and Chile. Currency devaluations and, in some instances, poor management of the pandemic only compounded the problem. None of this was ever likely to help rally stock markets, so it’s not too surprising the MSCI EM Latin American Index fell by 8.1% last year.
But as a former Soviet leader said, there are decades where nothing happens and weeks where decades happen. The start of 2022 has seen a dramatic turnaround in Latin America’s fortunes.
About 25% of the world’s agricultural products come from countries across the region. They also produce huge amounts of oil and gas, as well as metals, such as copper and lithium, which are vital to the global economy. With commodities prices continuing to soar upwards, it’s hard to see conglomerates in the sector failing to perform well in the near future.
Like their large neighbour to the north, Latin American countries also seem much more immune to the fallout from war in Europe.
There is some precedent here, too. During WWI, the number of factories in Brazil quadrupled. Surging demand for its industrial and agricultural products also saw its economy perform well during WWII, when it rapidly modernised its steel industry to cater to western demand.
Businesses in Latin America are being pushed along by these positive macroeconomic tailwinds at a time when they are trading at relatively low valuations. Last year’s poor performance led to some major sell-offs, with currency devaluations making things even worse.
Although 2022 has seen equities markets recover, listed businesses were still trading at a 25% discount to their historical average on a forward price-to-earnings basis in late March. Currencies across the region have also stabilised and have been among the best-performing in the foreign exchange market so far this year.
On the front foot
The BlackRock Latin American (BRLA) investment trust can gain access to these new opportunities. The trust is the only Latin America-focused closed-ended fund that invests exclusively in equities. It also pays a dividend equal to 1.25% of its net asset value at the end of each quarter.
BRLA underperformed last year but has been among the best-performing trusts in 2022 thus far. That’s partly due to its exposure to commodities producers in the region. BRLA’s two largest holdings are Vale, the world’s biggest producer of iron ore and nickel, and oil and gas giant Petrobras.
Those two firms alone make up close to 20% of the trust’s portfolio. Having said that, and as attractive as commodities players are at the moment, there is more to Latin America than agricultural products and stuff you can dig out of the ground. For instance, the biggest sectoral weighting in the BRLA portfolio is in financial services and the trust also has substantial exposure to consumer goods businesses.
Brazilian stock exchange operator B3 is one of the trust’s larger holdings in the former industry. Even adjusting for currency depreciation, the company has managed to deliver earnings growth of approximately 16% per annum in USD terms over the past five years.
That points to another strength of some of the companies in the BRLA portfolio. Although they’re now operating in favourable macroeconomic conditions, many of these businesses exhibit strong secular growth potential. Many also managed to batten down the hatches during the pandemic and have re-emerged from it on a stronger footing. Indeed, BRLA manager Ed Kuczma noted recently that companies in Latin America have the strongest balance sheets he’s seen during his 20 years investing in the region.
Of course, some of you may have read up to this point and only rolled your eyes. To paraphrase an old Israeli diplomat, Latin America is one region that many investors feel never misses an opportunity to miss an opportunity. And just as the macro gods may be imparting their favours on the region today, that could easily change tomorrow. Investors that feel inclined to think this way but are still interested in getting exposure to Latin America may find some solace in the trust’s proposed discount policy. The trust board is proposing that if BRLA trades at too steep a discount or fails to meet certain performance based criteria over the next four years, then it will commence a buy-back programme to return cash to shareholders. It’s not a perfect solution but it’s certainly a handy one to have for a volatile region. In the meantime, BRLA is continuing to see its discount narrowing. Perhaps some investors believe this is the opportunity Latin America won’t miss.
See also: BlackRock Latin American Investment Trust review