January 26, 2006

South American Investments Appear Headed North

With skyrocketing inflation, unstable regimes, and other problems that have plagued South America in recent years fading from the picture, the outlook for investments in the region appears bright this year.

Looking out at 2006, Standard & Poor's remains bullish on Latin American equities based on a view of strong earnings growth coupled with attractive valuations.

Alec Young, a Standard & Poor's equity market strategist, thinks prospects for the region look good because inflation there, which had been among the highest in the world a few years back, has been decreasing, as have interest rates. At the same time, the region has become less volatile politically as democracy has increasingly taken hold.

Companies south of the border have also benefited lately from strong demand for oil and raw materials from China, India, and the U.S. Meanwhile, at home, growing middle classes with fattening incomes have been clamoring for things like cars and appliances, further spurring economic growth on the continent, Young said.

Given this backdrop, Standard & Poor's estimates that companies in its Latin America 40 index will be able to increase earnings by 12% this year. The index includes the largest companies with the most liquid stocks in Brazil, Mexico, Chile, and Argentina, but the first two countries account for the vast majority of its holdings -- 87%.

The index was up 50.2% in 2005, making Latin America the best performing regional equity market in the world for the 12-month period. By comparison, the S&P 500 index, a broad gauge of the U.S. stock market, gained 4.9%.

Paul Rogers, lead manager of the Scudder Latin America Fund (SLANX), shares Young's optimism about the region. He feels companies there can increase sales by 10%-12% and improve earnings before interest, taxes, depreciation, and amortization by about 15% this year.

Among individual companies, Rogers likes Petroleo Brasileiro S.A. (PBR), a Brazilian oil and natural gas company known as Petrobras, because of its global operations, and because he expects its production to increase.

Another of his favorite companies is Companhia Vale do Rio Doce (RIO), a Brazilian iron ore producer that he sees as a beneficiary of demand from China. The company and Petrobas were among the largest holdings in the $700 million fund at the end of last year.

At that time, other top holdings in the fund, which has the bulk of its assets in Brazil and Mexico, included two Mexican companies: America Movil SA (AMX), which provides wireless communications services, primarily in South America; and Cemex SA de CV (CX), a cement company that Rogers said is the largest supplier of that material to the U.S.

Scudder Latin America returned 52.1% last year, while the average Latin America fund gained 53.9%. The T. Rowe Price Latin America Fund (PRLAX), which was up 60.1%, was the best performer in the group, which, excluding multiple share classes, features only a handful of funds.

Over the three-year period through 2005, the average Latin America fund rose 50.8% (annualized), with Merrill Lynch Latin America Fund/I (MALTX) posting the top return at 55.6% (see table below).

People can also invest in the region through iShares S&P Latin America 40 Index (ILF), an exchange-traded fund that tracks that index. Unlike mutual funds, exchange-traded funds trade throughout the day. Annual operating expenses generally run much lower.

Other ETFs focused on the region include the iShares MSCI Brazil Index Fund (EWZ) and the iShares MSCI Mexico Index Fund (EWW).

"As part of the aggressive part of an investor's equity portfolio, we think an allocation to emerging markets, and, more specifically, to Latin America, makes sense," Young said.

Because Latin America mutual funds invest most heavily in Brazil and Mexico, Rosanne Pane, mutual fund strategist at Standard & Poor's, recommends that fund investors get exposure to the region through international funds, which buy stocks of companies all over the globe.

Pane also warns that Latin America funds or similar offerings that invest in emerging markets can be risky. "You don't want to make a big bet in this type of market," said Pane, who recommends that investors allocate at most 5% of their portfolio to emerging markets funds.

In light of Latin America's reliance on exports, Standard & Poor's believes the primary risk to equity markets there this year would be a global economic slowdown led by the U.S. and China, which would curb the need for petroleum and other commodities. But that scenario appears unlikely.

Politics is also a wild card in the company's outlook as both Brazil and Mexico face presidential elections this year. However, regardless of whether power changes hands in Mexico and Brazil, Standard & Poor's believe that all the key political parties are much more market-oriented than in the past, which should limit equity volatility.

TOP PERFORMING LATIN AMERICA FUNDS FOR 3-YR.* PERIOD

FUND

Annualized Return (%)

3-Yr. Standard Deviation (%)

Expense Ratio

Merrill Lynch Latin America Fund/I (MALTX)

+55.6

20.4

1.60

Fidelity Latin America (FLATX)

+53.7

20.0

1.04

Fidelity Advisor Latin America/Instl (FLNIX)

+53.0

20.3

1.30

iShares S&P Latin America 40 Index (ILF)

+52.1

19.7

0.50

T Rowe Price Latin America Fund (PRLAX)

+51.8

20.1

1.29

Avg. Latin America Fund

+50.8

20.3

1.81

*SOURCE: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Preliminary data as of 12/30/05.

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.

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