Latin American funds have recorded an extraordinary run. During the three years ending in August, the funds returned 52.6 percent annually--topping all other categories tracked by Morningstar. The enormous rally can be attributed to changes that have been sweeping the region. For a decade beginning in 1994, Latin American stocks stagnated while governments struggled with high inflation rates and shaky currencies. But that began to change in recent years. Governments in countries such as Mexico and Brazil reduced inflation by cutting budget deficits. With inflation lower, the purchasing power of consumers grew. Customers began flocking to department stores and banks. Seeing their economies improving, many local investors have been pouring money into stocks. That has propped up markets throughout the region.
At the same time that stock markets were beginning to rise, prices began soaring for commodities such as copper, oil and sugar. This brought enormous wealth to Latin America. Much of the new income went to pay down loans. Instead of being debtor nations, many countries began piling up reserves of hard currencies. Now much of Latin America seems poised to continue growing faster than the U.S.
After the big rally, have the Latin stocks become overpriced? Not necessarily. The price-earnings ratio on holdings of Latin American funds is 17, according to Morningstar. That is not cheap. But prices are not excessive for many stocks which are reporting double-digit earnings growth.
Make no mistake, Latin American markets remain volatile. Still, investors may want to spice up their portfolios by holding a small stake in a fast-growing region.
Which Latin fund makes the best choice? To find a winner, we turned again to the eight-part screens developed by Donald Trone, chief executive officer of FI360, a consulting firm in Sewickley, Pa. Trone's due-diligence process seeks to find funds that are at least three years old and have a minimum of $75 million in assets. At least 80 percent of holdings must be consistent with the category. One- and three-year total returns must exceed category medians, as must five-year results if the fund is that old. Alpha and Sharpe ratios must also top category medians. The expense ratio must fall below the top quartile.
The screens reduced the field from 18 contenders to five finalists. Top performers included BlackRock Latin America and Fidelity Advisor Latin America. But we awarded the title to T. Rowe Price Latin America, which had the highest Sharpe ratio and alpha score of any finalist.
T. Rowe Price portfolio manager Gonzalo Pangaro delivers winning results by buying stocks with growing earnings that sell at moderate prices. Many of his holdings are the big blue chips of the region, but he also takes small and mid-sized stocks that seem likely to deliver long-term growth. After buying a stock, he typically holds it for four or five years. While the average Latin America fund has an annual turnover rate of 97 percent, T. Rowe Price has a turnover of 35 percent. "Sometimes the market focuses too much on the short-term outlook for a company," says Pangaro. "We try to consider how the company will be performing a few years out."
Emphasizing companies with strong growth, the fund has sizable positions in the cellular phone industry. Cell phones still have relatively low penetration in Latin markets, and companies are growing rapidly. In contrast, T. Rowe Price is avoiding landline phone companies. "The fixed-line companies are not growth stories, and the service is expensive," says Pangaro.
A big holding is American Mobile, a Mexican company that is growing rapidly by bringing cellular service to countries throughout the region, including Mexico, Brazil, Argentina and Colombia. The company has added 12.5 million subscribers in the last six months, bringing the total to 137 million. Revenues are rising at a 28 percent annual rate, while earnings are growing by 41 percent.
Another blue-chip holding is Petroleo Brasileiro, a giant Brazilian oil producer. While much of its production is in the home country, the company is also spending $2.8 billion to develop fields in Argentina. "This company has enormous potential to expand its production," says Pangaro.
A growing resource holding is Companhia Vale Do Rio Doce, which produces iron ore in Brazil. The company has long-term supply contracts with steel makers in Japan and other countries. Last year, the Brazilian company paid $17 billion to buy Inco, a Canadian producer of nickel and platinum. The investment should help to diversify the company and enable it to maintain strong growth.
Pangaro makes little effort to track a benchmark. Instead, he focuses on finding attractive stocks wherever they may be. That sometimes leaves the fund overweighted in certain industries or countries. At the moment the fund has few holdings in Chile, because Pangaro says that the stock prices are rich. He is overweighting Brazil where stocks are cheaper. In addition, the Brazilian economy is enjoying strong growth. Gross domestic product should grow by about 4.5 percent this year and next, according to the Brazilian government. Interest rates on government bonds dropped from more than 14 percent a year ago to 11 percent [as we go to press]. "As the interest rates fall, domestic investors are shifting from bonds to stocks, and that is pushing up share prices," says Pangaro.
A fund holding that is benefiting from growing consumer demand in Brazil is Lojas Renner, an operator of mid-price department stores. The chain's sales have been rising at a 24 percent annual rate. That kind of rapid growth should help T. Rowe Price Latin America continue its strong performance.
Stan Luxenberg (firstname.lastname@example.org) is a New York-based freelance business writer and a longtime regular contributor to Wealth Manager.