By Viktor Szabo, Investment Manager, abrdn Latin American Income Fund Limited
- There are two elements in the region’s favour: exciting companies and economic recovery
- The region has been hit disproportionately hard by global inflationary pressures, but this is likely to have peaked
- Economies are starting to recover, helped by high vaccination rates.
Investing in Latin America is seldom straightforward – and proved particularly tricky in 2021. Looking into 2022, however, there are two elements in its favour: exciting companies and economic recovery. These two elements could suggest better returns for investors across the region in the year ahead.
At a time when the rest of the world has seen significant economic recovery, Latin America has had some headwinds. While the region would normally be a significant beneficiary of global recovery, supply chain disruption in the wake of the pandemic has held back countries such as Mexico, which are strong in car making. There has been plenty of demand, but distribution has been difficult.
The region has also been hit disproportionately by global inflationary pressures. In Brazil, inflation surpassed 10% last September, necessitating the continuation of an aggressive interest rate hiking cycle. This was a blow to stock markets, which had started to anticipate better times ahead. While Brazil saw the greatest inflationary pressures, there were difficulties across the region and many central banks raised rates.
A turning tide
This has been a tough backdrop for the abrdn Latin American Income Fund to navigate. However, these rate rises are now reflected in the price of Latin American equities and bonds. Equally, the Brazilian central bank believes inflation may have peaked in the region*. Higher rates are already starting to have the desired effect of calming price rises. Latin America may prove to be ahead of the rest of the world in its rate cycle.
Economies are starting to recover. This recovery has been helped by high vaccination rates. Brazil has around two-thirds of its population double-vaccinated, with Chile and Uruguay even higher. Mexico is a relative laggard, but still has over half of its population immunised against the virus. The recovery was more robust than expected last year with IMF revising its outlook for the broad region in October and adding 1.7% points to its previous forecast; Brazil’s economy is forecast to have grown by 5.2% in 2021 and Mexico by 6.2% last year.
The global inventory cycle and high inventory prices should be supportive for the region. The world needs to build back all its stockpiles, having run them down during the pandemic and the region is a treasure trove of natural resources. The theme of reshoring could also be interesting for Latin America, particularly for Mexico. The pandemic has exposed the difficulties of long supply chains that reach across continents and US companies are moving production closer to home.
Stock markets in Latin America had a tough 2021, hit by rising interest rates. Assets have repriced to reflect a higher cost of capital. As inflationary pressures have risen, those companies without much pricing power have been hit particularly hard. Their cost base has risen, but they haven’t been able to pass those costs onto their customers. This has also weighed on certain equities.
For example, we have seen technology adoption accelerate across the region, creating opportunities within ecommerce, fintech and education. We hold Mercado Libre, for example, Latin America’s Amazon equivalent. We have XP Inc, an innovative brokerage firm in Brazil.
Infrastructure is also likely to be a priority for governments across the region, creating real opportunities for investors. With that in mind, the trust holds OMA, an airport operator in Mexico, plus a railway operator in Brazil. At the same time, environmental awareness is creating opportunities in sustainable agriculture.
In line with its long-term investment strategy, the trust remains overweight those companies that are highest quality at decent valuations. The largest overweight positions are in the consumer discretionary sector, followed by industrials, real estate, information technology. The trust is geared, meaning that it has borrowed money for investment purposes, endeavouring to capture the domestic consumption story across the region.
Strength in income
It is also worth highlighting the recovery in dividends in Latin American countries. Many companies were prudent during the pandemic, choosing to keep liquidity to hand at a time of uncertainty. However, many have resumed payouts as the outlook has improved. There is still potential for future improvement as recovery comes through.
The shifting interest rate environment has also created opportunities within fixed income. Yields have risen and that has created some flows into fixed income over equities. That said, the trust retains a slight overweight to equities over fixed income, based on continued economic recovery and higher inflation. Where we are invested in fixed income, we are moving into shorter-dated bonds, and have an overweight position in Uruguay, where the quality of the institutions is very high and political risk is low.
The pandemic has exposed some of the long-standing inequalities across Latin America – particularly in healthcare and education. It has also raised concerns about the distribution of profits from natural resources. The state’s role can hardly go back to pre-Covid levels, but the question is how far the state should reach. That will be decided in the next months and years. To our mind, this could be a catalyst for positive change across Latin America, including more equality and better public services. We are seeing early signs of this already.
Some risks remain. There is a busy year of elections coming up and this creates the potential for volatility. In Brazil, there is a danger that President Jair Bolsonaro takes significant fiscal risks in an attempt to shore up his popularity. However, these risks are known and understood by markets.
Overall, 2022 has a brighter outlook than 2021. The country’s stock markets could benefit from falling inflation, global economic recovery and the blossoming of a number of longer term structural trends, even if the elections create some short-term instability.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- The Company may charge expenses to capital which may erode the capital value of the investment.
- Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
- Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
- With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘sub-investment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends with match or exceed historic dividends and certain investors may be subject to further tax on dividends.