Abundant low-cost commodities, renewed investor interest and an emerging IPO boom are among several factors set to benefit the Latin America region, according to BlackRock’s Ed Kuczma.
The global economy appears to be at the start of an exciting moment in terms of global cyclical recovery and Latin American equities could be well placed for a coinciding boom, he argued.
“Latin America is home to a great deal of really abundant natural resources,” he said.
“When we look at mining and commodities in Brazil, Chile and Peru, these are countries with very low-cost production and very long-life reserves for various commodities. The cost of production is also usually on the first quartile globally.”
As industrial production goes up across all regions and economies come out of the pandemic, the BlackRock manager anticipates demand for these commodities will increase.
This is one of the reasons why he is overweight materials in the £169m BlackRock Latin American investment trust. The largest position is Brazilian-listed miner Vale, one of the biggest mining and metals producers in the world.
Kuczma said: “We think that commodities will be a great tailwind for the region and, usually when you see commodities in past come up during commodity booms, you've seen a very tight correlation with the domestic cyclical factors as well.”
Once vaccines are more widely rolled out across Latin America and their economies open up, he believes this tailwind will start to come through and benefit other sectors as well, not just materials.
“Historically, whenever you see Latin America with negative returns as they were last year, there's usually a strong bounce back effect in the following year as things get too oversold,” he said.
“It's kind of like a pendulum swing, and I think it's swung a little bit too far. I think we're going to bounce back and have a strong swing to the positive side this year.”
Over the past two years, Latin America has lagged the performance of Asia and Europe, the Middle East and Africa (EMEA).
Performance of Latin America, Asia and EMEA equity markets over 1yr
Source: FE Analytics
Indeed, the currencies of many Latin American countries have been declining over the last few years and it has been exacerbated by the coronavirus crisis. But with rising commodity prices, many of these currencies could be poised for a roaring comeback.
“When we look at our real effective exchange rate models, Latin American currencies are some of the cheapest currencies in the world,” Kuczma said.
“They have been depreciating in value for the last five years and normally when you get just such strong commodity prices, you'll see a very strong shift to current account surpluses and the terms of trade improve.
“Markets like Chile, Peru and even Mexico with high relatively high interest rates should benefit from more of a risk-on or a carry trade type environment where investors will look for high yielding emerging market currencies to benefit from this appreciation potential.”
With globally higher rates looming on the horizon as the US 10-year treasury yield increases, Kuczma is also seeing a big rotation out of traditional secular growth tech leaders into more value-type investments.
“We think that with commodities, energy and financials being more than 50 per cent of our benchmark, there's a lot of stocks there that have been under-owned and are undervalued that should do well in this rotation from momentum into value,” he said.
“Most investors globally, they're just under invested in the region. It's under-researched, it's under-owned and undervalued, whilst we are getting pretty strong reversion and earnings growth here.”
However, the BlackRock Latin American manager cautioned an approach that involves just buying the entire equity market through a passive ETF.
“You get a lot of these state-owned companies that have really been almost taken hostage in the past by the government, whether it's hiring more people than they need, or putting politicians at the roles of the CEO or CFO,” he said.
“Which is why we like to see good quality corporate governance and that is a defining factor for us.”
He also highlighted the volatile nature of the political cycle in Latin America as another reason why being active in the region is beneficial.
“I think the volatility specifically provides active managers with a good opportunity set to go overweight and underweight and be tactical,” he explained. “For this trust we can use a gearing, so we can really juice up the returns and go overweight high conviction ideas.”
Indeed, the manager runs quite a concentrated portfolio, with roughly 40 names in the fund.
He also noted a recent boom in the IPO pipeline emerging in the region as being indicative of the Latin American equity markets becoming broader and deeper.
He believes this has been largely a result of lower interest rates across the region. Three years ago, Brazil had an interest rate of 14 per cent whereas today it is roughly 2 per cent.
In the past with such high interest rates, local institutions could invest in fixed income without the need to take equity market risk to enhance returns. But this is now changing, according to Kuczma.
“You’re seeing lot of institutional investors, insurance companies and pension funds locally invest diversifying into the equity markets because they need more returns to match their objectives, and this is supplying a lot of capital to the equity markets,” he explained.
“We're seeing a lot of innovation and entrepreneurial companies in the tech sector, the hospital and medical sector and the agricultural sectors, in terms of IPOs.
“This is a positive development for the region and gives investors more choice. This also adds some higher growth names that we’ll have the potential to invest in.”
Since Kuczma started managing BlackRock Latin American at the end of 2018, it has delivered a total return of 0.93 per cent versus a 3.34 per cent loss from the only other trust in the IT Latin America sector and a 9.97 per cent loss from the MSCI Emerging Markets Latin America benchmark.
Performance of the trust versus sector & benchmark
Source: FE Analytics
BlackRock Latin American trades at an 8.9 per cent discount to net asset value (NAV) and currently yields 4.8 per cent. It is 6 per cent geared and has ongoing charges of 1.13 per cent.