Although Latin America's leading economies have stabilised since the mid 1990s, the region is still perceived by many global equity managers as one plagued by economic and political volatility.

Past crises such as the ‘tequila effect' devaluation of Latin American currencies sparked by the Mexican peso's collapse in 1994, Brazil's 1999 currency crisis, and debt defaults by Argentina and Ecuador remain uppermost in the minds of many. Wary of short-term losses, investors are reluctant to commit themselves, turning instead to Asia as an emerging market alpha source. However equity managers are ignoring the long-term investment opportunities available in Latin America.

Even the sceptics acknowledge Latin America's major economies now boast more solid fundamentals. A commitment to orthodox fiscal and monetary policies from governments and central banks has seen inflation fall significantly in countries such as Brazil, Chile and Mexico, creating an environment conducive to domestic growth and investment. Demand for commodities has led to trade surpluses. Tax reforms and prudent government spending policies have given rise to current account surpluses in many countries, and economies are now more stable and less dependent on foreign inflows of capital, while company balance sheets are also carefully managed.

Meanwhile, Latin American politics is losing its dangerous colour. Changes in government are becoming more orderly and many administrations have embraced market reform. In spite of the fears that accompanied populist, left-wing Brazilia, President Luiz Inacio Lula da Silva's election win in 2002, the country has moved towards privatisation and market reform, while Chile, with its strong record of economic growth and exemplary pension system, is the region's star performer.

Of course, not all governments are willing to rely on market forces. Recently re-elected Venezuelan President, Hugo Chavez, continues to pursue populist policies backed by the country's extensive oil resources while a large proportion of the population languishes in unemployment. Inspired by Chavez and buoyed by high commodity prices, other Latin American countries such as Bolivia, have pursued similar policies, including the nationalisation of assets. In the short term, such measures have proved popular but over the long-run such policies will make the inevitable economic adjustments harder to deliver.

Latin America's most successful economies look favourable when contrasted with those of the US and UK, where personal and government debt are soaring, suggesting protracted downturns loom in the long term. At current valuation levels, neither the US nor UK equity markets reflect the risks associated with this scenario. Emerging markets like Latin America, where the major economies' consumers and governments are comparatively free of punitive debt, and equity valuations are relatively low, look increasingly attractive. We see plenty of well-managed Latin American companies trading on attractive valuations in comparison to companies in developed markets.

Companhia Vale do Rio Doce (CVRD), in Brazil, is the largest natural resources company in the world, and has mineral assets that are the envy of nations such as China and India. The recent acquisition of Inco has diversified CVRD's earnings and made it more comparable with global mining players such as Rio Tinto, to which CVRD still trades at a discount.

However, it would be wrong to view the region purely as a play on the world's thirst for commodities. We also believe exposure to growing consumer demand in the region is becoming increasingly attractive. While US interest rates have risen dramatically over the last two years, leading Latin American economies like Brazil have pursued more accommodative interest rate policies. As long as high energy prices do not stoke inflation too much, interest rate cuts could continue in the near term, further stimulating domestic demand and investment. Meanwhile, as the region's economies grow, the rise of the middle classes will provide a further boost to consumer demand.

Against this background, the opportunities at the company level are plentiful. Take Soriana, a supermarket owner and operator based in the north of Mexico, which is highly leveraged to domestic and consumer growth but trades on a valuation of 13x 2007 earnings estimates. This compares very favourably to J Sainsbury in the UK, which is trading on 22x 2007 earnings, particularly when you consider that sales are growing at 11.3% per year compared to 5.7% at Sainsbury. In addition, we have added well-run Mexican home builder ARA to our portfolios; a likely beneficiary of the brisk domestic demand for housing within the economy.

 

emographics also look favourable over the long term. According to 2006 UN figures1, only 9% of the population of Latin America and the Caribbean was over 60 years of age in 2006, compared with 20% in the world's most developed regions. By 2050, 24% of Latin American and Caribbean people will be over 60, compared with 32% in the world's most developed nations, according to UN projections. While economic growth in developed economies is likely to be limited in the medium term by comparatively more aged populations, growth in Latin America and other emerging regions will be fuelled by a ready supply of labour along with strong domestic consumption trends.

Of course, investment in Latin America still has its pitfalls. While many of the region's smaller economies are relatively stable today compared to the recent past, this stability remains fragile. In a continent of countries rich in energy and mineral resources, adverse political events, like Chavez's recent threat to end oil sales to the US; the political uncertainty in Mexico surrounding the election of Felipe Calderon; or Bolivian President Evo Morales's decision to put the country's energy industry under state control, inevitably lead to market jitters, and short-term volatility is a definite risk for the investor. For this reason, we look to invest in good quality companies over the long term.

As with any market, the risk of investing in a poor company is another factor. However, despite perceptions that corporate governance, disclosure and transparency are not up to scratch in Latin America, in actual fact the region's listed companies have improved dramatically on all these levels. As complex tiered share class structures have disappeared, shareholders are increasingly being treated equally and fairly, and the evidence of higher dividend yields and of surplus cash being paid out to shareholders is also encouraging. Furthermore, scandals involving Worldcom, Enron and Parmalat have highlighted that poor governance is a problem worldwide, not just in emerging markets.

Latin American stocks have been fairly robust lately, more than regaining the ground lost since May 2006's global correction, due in part to an easing of concerns over the health of the US economy. Looking at the region's longer term history, the MSCI Latin America Index has outperformed other major world indices such as the MSCI World in 10 out of the last 15 years.

Of course, as with all markets, there can be no guarantees going forward. In the near term, the biggest issue for Latin America remains the level of impact a US slowdown could have on global growth. A significant US slowdown would have a knock-on impact on exports out of emerging markets like Latin America and therefore an overall impact on their economies. We continue to favour consumer-led Latin American companies, so it could be argued that we are less sensitive to US growth or to a possible slowdown in exports. Another short-term risk is that consistently high oil prices could drive inflation. Domestic interest rates would then be forced upwards, curtailing domestic demand.

Nevertheless, it is the long-term story that is important. Our analysis of the region's investment propositions reveals some well-run, undervalued companies with good asset-backing, healthy balance sheets and improving corporate governance. We believe shares in such companies will perform well over the long term. At the same time we are optimistic that the majority of Latin American countries will continue to stabilise politically and grow economically with the help of prudent fiscal policies.

1United Nations Department of Economic and Social Affairs, Population Division, Population Ageing figures 2006. HYPERLINK "http://www.unpopulation.org" www.unpopulation.org

Mark Butler is senior investment manager at Aberdeen Asset Management

Topics