With developed markets becoming increasingly turbulent with little clarity on Brexit and renewed talk of a US-China trade war many investors may wish for a calmer political environment. But BlackRock Latin America Investment Trust manager Ed Kuczma said the opposite is true of his area of focus.
The manager of the £180.6m closed-ended fund said that it is the political volatility of the region that creates some of the best investment opportunities.
This is particularly true of Brazil and Mexico where he channels the majority of his highest conviction ideas as their politically shifting climates produce the best returns.
“I think that the opportunity is going from a negative to a positive,” Kuczma explained. “In Brazil they had two consecutive years of negative 3 per cent GDP and we believe that if you pull the rubber band down in one direction when you let go the rebound will be that much stronger. And they’re right in that rebound now.”
The BlackRock Latin America Investment Trust fund is considerably overweight in the more politically volatile parts of the region and underweight in more stable areas.
As such, it has its biggest overweight in Brazil – which represents almost 72.2 per cent of its net asset value (NAV) – 11.6 per cent higher than the MSCI Emerging Markets Latin America benchmark.
Performance of indices YD
Source: FE Trustnet
Mexico, it’s second largest country allocation represents 30.1 per cent of the trust’s NAV and a 6.5 per cent overweight relative to the index. (The trust is 10 per cent geared.)
The reason for these overweights, said the BlackRock manager, is that markets respond well to elections in both countries last year.
This puts them in the “sweet spot phase” of having hit the bottom of the macroeconomic cycle already and now climbing out of it, according to Kuczma.
“We’ve seen in emerging markets that when they go through a political election and change that the markets love it and the markets rally,” he explained. “That’s the reason why we’re overweight Brazil.
“Brazil is going through a major political overhaul after 20 years of leftist political regime.”
The BlackRock Latin America trust manager added: “It’s been a slow recovery but once we get pension reform done – which I think will happen in about August or September this year – that will be the green flashing light, and companies will start to invest more, unemployment will go down and, consumption will increase. Inflation is now at all-time low. Interest rates have decreased.
“All these stars are aligned for Brazil to have a period of significant growth. So that lends to our higher conviction in Brazil.”
Turning to Mexico and Kuczma admitted that, whilst he is slightly surprised that their valuations are not as cheap as they have been there are still opportunities
Those will not be derailed by US president Donald Trump tweeting threats of new Mexico tariffs, the manager added.
“In Mexico there’s a lot of fear in terms of what the policy is going to be,” he said. “We’ve seen last week some of the debt rating agencies downgrading their outlook for Mexico and their rating.
“Whilst that’s a negative macro development the valuations in Mexico are really cheap.”
Kuczma explained: “The thing with Mexico that helps make it look so cheap is that growth estimates have been revised down consistently throughout this year and the market is saying that they think these downgrades are going to continue. I think at some point there’s a flaw to it.
“We like buying cheap currencies, weak markets in terms of economic growth and attractive companies with good fundamentals. Mexico checks off a lot of the boxes.”
This checklist of opportunities, for Kuczma, have arisen as a consequence of these volatile political events, an element which is absent in Chile, the fund’s biggest underweight.
Kuczma said its underweight positioning there was due to Chile’s stable political nature meaning that the market opportunities borne from-political issues has come and gone.
“Chile is an area that we’ve been most underweight in the fund and we’ve been underweight in Chile for a while,” he said. “Chile is stable, you know what you’re getting.”
This heightened consideration of the macroeconomic picture forms part of the manager’s portfolio construction process, which focuses on the four ‘Cs’ of Latin America: commodities, consumption, currencies and credit.
He combines this with a ‘macro-dashboard’ and a quantitative screen to produce, what he describes as a ‘movie rather than a snapshot’ of the state of a particular country.
“Across the market there are people who are overweight or underweight,” he said. “We want to veer a little bit against consensus, where can we see revisions in terms of economic growth and earnings growth.”
Looking at Latin America as a whole, Kuczma sees that from a top-down perspective that the region appears to be in an upswing period.
Having taken over the trust in December of last year the manager explained that, whilst he is foremost a bottom-up investor, the fund’s process has had to be altered somewhat from his predecessor’s 99 per cent bottom-up analysis of individual stocks to encompass a wider view of a region that is unquestionably affected by major macroeconomic and political themes.
He said: “In this region there’s a lot going on politically and economically that we can’t just ignore the top-down [view]. We are doing more structure macro approach than we did under the former portfolio manager.”
Having worked with the previous manager, Kuczma said the trust has not been drastically changed, but has become more focused while its top-down process has led it to more unstable areas in the region adding more active risk to the portfolio.
This he feels, will enable the fund to fully outperform against the MSCI Emerging Markets Latin America index.
He said: “We are going to focus more on our highest conviction ideas. It’s going to be a more concentrated portfolio so closer to 40 stocks.”
Kuczma joined the trust in December 2018 and is co-manager alongside veteran emerging and frontier markets investor Sam Vecht.
Over the past three years, the trust has made a total return of 63.28 per cent against a rise of 61.80 per cent for the benchmark and a 59.45 per cent gain for the average IT Latin America peer.
Performance of trust vs sector & benchmark over 3yrs
Source: FE Trustnet
The trust has a dividend yield of 5.2 per cent is trading at a discount of 14.7 per cent to NAV and has ongoing charges of 1.05 per cent, according to the Association of Investment Companies.