Foresight

Re-appraising the case for Latin American equities


Latin America is a region which has long offered promise for investors, but its equity performance has disappointed over the last decade. The share of Latin American markets in major equity indices over this period has shrunk as investor interest has waned, and as Asian markets, in particular China, have become increasingly significant.

After a decade in the investing wilderness, is it time for investors to reappraise Latin America?

Read the full paper: Re-appraising the case for Latin American equities

So far this year, the region has been the standout among equity markets globally. As at 31 October, it has managed to generate a positive return (+13%) in US dollar terms while most major markets have suffered severe drawdowns; outperforming the MSCI World by 33% and the MSCI Emerging Markets (EM) by 43%. In local terms, outperformance is 25% ahead of the MSCI World and 32% ahead of the MSCI Emerging Markets Index.

It is well known that Latin America is abundant in resources, from industrial and precious metals through to oil & gas, and soft commodities such as soya and sugar. A pick-up in global commodity prices was underway even before the spike triggered by Russia’s invasion of Ukraine. More recently, slowing global growth has weighed on industrial metals prices, but there may be longer-term support from the quest to reach net zero. Latin America’s geographical location, far from Russia’s war in Ukraine and the threat of escalation, insulates the region from many aspects of supply concerns.

There is good reason to think that Latin American equities can play an important role in investors’ portfolios. Positioning is low relative to history, as well as relative to the region’s economic might, and valuations are appealing. In a fast-changing world, it could be well positioned to benefit, even if structural policy changes may in some cases be hard to envisage.

Longer-term factors such as the energy transition, which has already spurred a dramatic increase in demand for industrial metals such as lithium and nickel that are used in the manufacture of electric vehicles, will also be important. Nearshoring, as companies seek to re-orientate supply chains to reduce the risk from potential disruption and address ESG concerns, is already underway. Demographics too remain more favourable than many other major emerging and developed markets. And there are thematic opportunities in areas such as ecommerce and infrastructure.

Of course, there are risks. Resource dependence has historically left the region very prone to cycles of boom and bust. Meanwhile, political and policy risks, which have often gone hand in hand with issues of resource dependence, and the impact of US dollar strength are other issues to be aware of. And with ESG considerations increasingly important and embedded in investors’ decisions, additional risks are now present, and these cannot be ignored.

Latin America’s importance has dwindled

Latin America was once the most important region in EM equities. But, as the chart below illustrates, its weight has been decreasing since the early 1990s. In aggregate, Latin American equities now make up just 10% of MSCI EM, and around 1% of the MSCI All Country World index (ACWI). It punches a long way below the region’s 5% share of global GDP.

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Why it is worth re-appraising Latin American equities

This fall from grace has been driven by a combination of:

– The rise of Asia: MSCI EM is now 76% Asia, dominated by China (27%), Taiwan (14%), and Korea (12%).

– A decade of dire performance relative to other regions, driven in part by the skew of the regional economies and equity markets towards the underperforming value style (compared with Asia’s growth style-bias), including commodity companies.

The style skew of the EM index has been moving closer to balance in recent months, as China in particular has underperformed. But the present make-up of the MSCI EM Index is still not balanced. It involves a lot of Asia, which in recent years has become dominated by the growth style, which is not necessarily desirable in the current climate. There are good reasons to believe conditions may now be more favourable for the performance of Latin American equities:

  1. The commodity curse could turn into a blessing
  2. Mexico in particular stands to be a beneficiary of nearshoring/deglobalisation trends
  3. Its demographics are in much better shape than many other markets
  4. Its stock market valuations are historically cheap in absolute terms and relative to other markets
  5. It diversifies the country, region, and style exposure of the now very concentrated MSCI Emerging Markets Index

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There are also particular thematic opportunities within Latin America which have the potential to boost individual company and sector performance.

Unfortunately for most investors, if we do enter a period of outperformance from Latin American equities, this will amount to barely a rounding error in the performance of a global equity portfolio organised along MSCI AC World Index lines. Investors will need to look to a dedicated allocation to the region if they want it to make any difference.

What does this all mean for investors?

Latin American equities are historically cheap and, with a track record as a good diversifier of Chinese equities exposure, can improve the efficiency of investors’ portfolios. Commodities will continue to be a key driver of equity markets within the region, but with a more favourable outlook. In a dynamic and increasingly less certain world, Latin America may well benefit from many global trends; be it due to longer-term ones such as energy transition, or simply as a reliable trade partner. Re-design of global supply chains is a theme with the potential to boost GDP growth and aid market returns. And then there are growth themes that are more domestic, such as healthcare, e-commerce and infrastructure.

One need not be a contrarian to see how the region could play an important role in portfolios. But, with the region having shrunk in capital markets significance over the past decade, most investors will not stand to benefit. It is only with a dedicated allocation to Latin American equities that the benefits can be realised.

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