Why should Asian investors, who better know the emerging markets in their own backyard, invest in Latin America?
The investment case in Latin America is underpinned by demographics, resource wealth, the rising middle class, improving corporate governance, and a dozen other drivers. Put simply, as a standalone investment case we believe it is extremely compelling. Specifically for Asian investors, adding exposure to the region within their portfolio helps provide a necessary balance — many investors still underestimate the benefits of diversification.
The two regions complement each other well — whereas natural resources stocks have a high weighting in the Latin American index, Asian markets have a much higher proportion of, for example, IT companies. It is easy for investors to fall into the trap of home bias, and invest in what they are familiar with, but we firmly believe that a diversified portfolio offers better results in the long term.
Do you have any caveats on Latin America that investors should know?
Looking specifically at Brazil, the country must strive to reduce its dependency on foreign capital. The country's current account deficit is presently comfortably funded by foreign investment, both foreign direct investments and portfolio flows into the capital account, and Brazil is a net foreign creditor, with large foreign currency reserves. However, in the event of a flight of capital, this model carries significant risks. Brazil must, therefore, raise its savings rate, and in doing so, boost the investment rate, which has for too long lagged its emerging market peers.
The Brazilian government is also faced with the challenge of increasing the productive capacity of the economy through investment.
The risk is that fiscal discipline deteriorates and the government loses control of current spending. Recent moves, including the announced R$50 billion ($69.6 billion) cut to this year's projected spending, help allay fears in this regard, though there remains scepticism about the ability of the incumbent administration to rein in the fiscal deficit.
For Latin America as a whole, harnessing commodity wealth represents a major challenge that comes along with the huge potential reward. Avoiding the commodity curse, or the so-called Dutch Disease, from the potential deindustrialisation of the domestic economy through the excessive appreciation of the currency, must be a major focus for policy makers during the coming years.
Investors should note that Venezuela shows the downside risk when commodity wealth is mismanaged, and in contrast Chile offers a much more positive example.
How do you choose which companies to invest in?
These companies are those that are either first or second in their area of business or subsector — that takes into account both qualitative and quantitative considerations.
Essentially we look to invest in companies that differentiate themselves from their peers and create a sustainable business model that adds value to shareholders.
Clearly, at certain points in the cycle, quality companies do not necessarily translate into good investments at least not in the medium term.
However, we firmly believe that in the long run, the sector leader model adds value to investors. "We look to invest in companies that differentiate themselves from their peers and create a sustainable business model" Your Brazil sector leader fund, which is open to investors in Korea and the US, seeks to achieve long-term capital growth.
How do you plan to do that?
We invest in high-quality companies that generate returns in excess of their cost of capital. Our analysis looks to identify those companies that are mispriced by the market, and where there is a fundamental disconnect between the company's ability to generate earnings (and more importantly cash), and its quoted share price. The Brazil Sector Leader fund invests with a mind toward a long-term view, and we very much construct the portfolio based on fundamental analysis.
So how long is your investment horizon?
Essentially we are long-term investors, and our average holding period is around 12 months. However, as share prices change and fundamentals shift, we have to revisit our investment cases and take a view on existing and potential investments. If a stock reaches what we consider to be its fundamental value within a shorter period than expected, we will not be afraid to trim positions and reallocate that capital in other opportunities where we see more upside.
What's your one big pet peeve about investors in the region? (Now's your time to get on the soap box!)
There is still to some degree a short-term mentality that is not particularly conducive to realising fundamental value.
One of the most important challenges any investor faces is identifying what news is important. It still seems that there is a fair amount of noise created by the markets here, which can cause short-term share price distortions. Some investors in Brazil and Latin America would do well to bear that in mind and re-focus on the fundamentals. We are long-term investors, not speculators.
This story was first published in the April 2011 issue of FinanceAsia magazine