PLAYING A LATIN AMERICA REBOUND / THE WALL STREET JOURNAL

Playing a Latin America Rebound

The Resource-Rich Region Has Been a Laggard Among Developing Markets This Year, But It Could Be Poised for a Turnaround

By Murray Coleman

Nov. 22, 2013 6:42 p.m. ET

Though Latin America has been a laggard among developing markets this year, some investors are convinced that the resource-rich region is poised for a turnaround.

But many money managers are pulling away from Brazil—the 800-pound gorilla in Latin America—and looking instead at countries such as Mexico and Chile as better bets for long-term growth..

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"It's a mistake to look at Latin America as one big economy," says Mark Eshman, chief investment officer at ClearRock Capital in Ketchum, Idaho, which manages $400 million. "This region is made up of a very diverse set of countries."

Investors have found a lot to like in Latin America. The popular iShares Latin America 40 ILF exchange-traded fund has returned an average of more than 16% a year over the past decade. In that same period, the broad iShares MSCI Emerging Markets ETF  has returned slightly less than 12% annually.

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Lately, though, a slump in commodities prices has hurt the region's exports, particularly in Brazil. Much of that slowdown can be traced to China's move to build a more consumer-driven, locally focused economy. That has resulted in a dramatic reduction in trade with Latin America for raw materials and other key industrial goods.

So far this year through Thursday, the iShares MSCI BRAZIL ETF, which tracks most large- and midcap stocks in Brazil, has slid more than 13%. Since Brazil makes up nearly 60% of the MSCI Emerging Markets Latin America Index, that fall has had a dramatic impact on funds that invest in the region.

 

In contrast, the developing world as a whole, as represented by the iShares MSCI Emerging Markets ETF has slipped 4.7% in 2013. China is up 5.4% and Poland is up 6.3% year-to-date, according to MSCI.

 

Some investors say Brazil's challenges run deeper than exports. "Many people think of Brazil as an export-driven economy, but that's an overgeneralization," says Peter Lannigan, head of emerging-markets strategy at broker-dealer CRT Capital Group in Stamford, Conn. He estimates that exports comprise about 11% of the country's economic activity.

Mr. Lannigan blames much of Brazil's flagging investment sentiment on the country's economic policies. The government still has large stakes in major companies such as metals and mining producer Vale VALE +1.58% Vale S.A. ADS and integrated oil and gas developer Petróleo Brasileiro, Mr. Lannigan says. That tends to stifle innovation and make key competitors less nimble in adapting to changing market conditions, he argues.

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Also, price controls on markets such as electricity and gasoline distribution intended to tame inflation "are not creating a lot of confidence among investors," he says.

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In the short term, Mr. Lannigan agrees that Brazil's growth prospects don't look particularly good. Still, it is a "slumbering giant" that could return to double-digit growth over the next several years, he says.

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At a time when emerging markets are still broadly in a slump, owning a piece of Latin America's key player in a diversified portfolio makes sense for investors with longer time horizons, says Curt Klein, an investment adviser at Capital Investment Advisors in Atlanta, which has $1.3 billion in assets.

The firm currently has a small stake in the iShares Brazil ETF. Recently, Mr. Klein says he began wading back into the market. "As emerging markets start to emerge from a three-year slump, this seems like an attractive time to selectively build back positions," he says.

While Chile's economy is highly tied to copper prices, it's one of the best-governed in Latin America, says Ken Liu, a global equities strategist at RiverFront Investment Group in Richmond, Va., which has $4 billion in assets.
As a result, he says the market over the next decade is "one of the best growth plays" in the region with "strong demographics" favoring a youthful workforce. One fund the firm is considering buying is the iShares MSCI Chile CappedECH in Your Value Your Change Short position ETF.

Mr. Liu says the most interesting Latin American market in coming years could be Mexico. "It always has served as a strong manufacturing base for the U.S., but as wages rise in Asia, we've seen more companies move plants to Mexico," he says.

Another big plus: Market-friendly reforms could help make Mexico's economy more globally competitive over time and attract more foreign investment, Mr. Liu says.

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Since valuations in Mexico are high compared with historical ones, Mr. Liu suggests that investors might be better off remaining patient and watch as market reforms in Mexico take shape.

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Also taking a wait-and-see attitude toward Mexico is Jeff Davis, chief investment officer at Lee Munder Capital Group in Boston, which manages $5.7 billion. He says the iShares MSCI Mexico Capped   ETF is worth considering as a solo holding after such a turbulent 2013.

But small-cap Latin America stock funds should also be on investors' watch lists, Mr. Davis says. One he's following now is the Market Vectors Latin America Small-Cap Index ETF.

With the Federal Reserve still considering trimming its bond-buying program next year, and interest rates likely to move higher, Mr. Davis says global headwinds remain on the horizon for much of Latin America.

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"It makes sense in this environment to steer clear of big exporters and focus on smaller companies with greater access to the region's own consumers," he says.  

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