I will bet you a peso (okay, 100 pesos), that you think you know the answer to the following question: What is Latin America? But, if your high-net- worth client wants to cross the border with his or her hard-earned dollars, you might want to be able to answer the question with more than a shrug and an old joke about Montezuma’s revenge. The truth is that Latin America is an attractive emerging-market landscape where some countries are worth a hard investment look, and some are worth avoiding at all costs. (Hint: The countries you’d be most likely to vacation in are the countries you’d most likely want to invest in. Colombia? I wouldn’t vacation there with an M16; Mexico, I’d fish it in a minute.) But there are some investment vehicles that are detailed below that can help you take the bumpy road and back, with a high probability of putting money in your (U.S.) bank.
Latin America is generally considered to include Spanish or Portuguese-speaking nations of the Western hemisphere, usually not including the island nations of the Caribbean–which are relatively tiny economies and not particularly tied into the economies of the mainland.
This definition holds despite the protectionism of many of these nations, the fact that Mexico is a more natural trading partner to the U.S. than to the nations of South America, and in spite of the Central American economies being relatively undeveloped or small. Moreover, the regional concept is largely a matter of historical and language ties, combined with a largely shared emphasis on relatively low-wage, low-investment industries and agriculture.
The countries that predominate in any area-wide stock fund are, in order of market size: Mexico and Brazil, then Chile and Argentina, then Colombia and Venezuela. (The last two do not tend to be held in Latin portfolios; they are smaller markets, corruption and crime are rampant, drugs are the economic rampart, and they are even now actively at risk of violent insurrection.)
Latin America is cheap, and has the potential for great growth. Many stocks are selling for 12 times trailing earnings, prices not seen much in the U.S. in over a decade. But first the bad news: The unrealized potential of Latin America has long been notable. The old joke about Brazil holds that it’s the country of the future, and always will be. The joke could be told about the region as a whole. In fact, per capita GDP has been flat for the past half-dozen years. (On the plus side, inflation rates have come down from about 20% in 1995 and 1996 to 5% in 2001.) The unrealized potential of Latin America has long been associated with unstable and economically illiterate governments.
Looking at the longer term, in the 1940s, Argentina was among the richest nations of the world, but political conditions have since led that nation into a long relative decline almost as significant as that of Cuba.
Feeding its instability, Latin America has much greater disparities of wealth than the U.S. or Europe. Significant industrial output coincides with problems of debt, inflation and weak currencies, rural and urban illiteracy, poverty, corruption, political instability, and Marxist and related philosophies. Even “right-wing” governments have generally favored, or at least did not oppose, protectionist policies and government monopolies in the transportation, minerals, and utilities sectors. (Apart from Chile, the military regimes of the 1970s and 1980s were as bad at economic management as they were at protecting human rights.)
Informal business sectors and land ownership, high tax rates that don’t bring in much revenue, weak systems for obtaining mortgages and other loans, all are related problems–endemic to the region–that feed each other.
In many places (e.g., Argentina most recently), free-market reforms have aroused opposition from labor unions and leftists, while still leaving state control of the economy at European-style or higher levels. Naturally, there is some debate in Argentina whether the current troubles are due to excessive, or inadequate, reliance on free markets. But this should not surprise people who live in a country where some leading members of the left-leaning party blamed a recession on tax cuts.
Glass Half Full?
Let’s put it this way, we think that you can drink the water. True, Latin American backwardness is a problem, but it’s also the opportunity. Stock markets generally value corporations based on their current situations and their expectations of growth. If you know that a given manufacturer is selling for 12 times trailing earnings, the fact that vast populations can’t yet afford that manufacturer’s products is not a bad thing; it means that substantial growth is still possible. And as long as the situation of those who can already afford the products does not actually regress, such as in a recession or revolution, this manufacturer’s position is pretty solid.
Latin America hasn’t seen the advances of the Asian Tigers, but Latin America isn’t Africa, either. First, GDPs are about $10,000 per person for the four most advanced Latin nations, versus about $1,000 for many sub-Saharan African nations (and $36,000 for the U.S.). Latin America’s wars and coups also tend to be far less brutal (although recent low-intensity conflicts certainly aren’t good for business in, say, Colombia). The end of the cold war means these nations have reduced leverage to obtain U.S. aid, but also means that Marxist rebels have less philosophical and tangible support. (Of course, drug money remains.) And a relatively shared culture, language, and markets will help keep these markets increasingly tied.
Still, the area is diverse, and there really are only four countries that count for most stock investors:
Mexico, due primarily to its NAFTA-freed trade and immigration ties with the United States, now dominates most lists of the region’s publicly traded companies. While NAFTA is now quite popular in Mexico and with most U.S. businesses, much of the rest of Latin America–as well as U.S. politicians with large labor union support or from Southern areas with textile and other low-wage, low-tech industries–remains skeptical of the benefits of free trade, despite the Free Trade Area of the Americas (FTAA) regional trade agreement, which was proposed in 1994 and is supposed to arrive in 2005. Of course, it’s absurd to put such a thing on a fixed schedule when so many issues have to be worked out. But at any rate, Mexico’s acceptance now of trade seems permanent.
Brazil has a larger population than Mexico (175 million Brazilians compared to 102 million Mexicans), covers a lot of land, and has plenty of natural resources. But Brazil is well behind Mexico economically, with a 2000 GDP of $6,500 per person, vs. $9,100 in Mexico. Brazil’s rural inhabitants in particular are substantially poorer and less educated than those of Mexico.
While Chile has fewer than a tenth as many people as Brazil (15 million), and is the nation farthest from the U.S., it’s also the one closest to Western standards in terms of laws, accounting, currency, and political stability, and it may be welcomed into NAFTA before the rest of the region. Hence it is the third largest holding in most Latin American portfolios. Argentina’s 37 million citizens are the richest of the group ($12,900 GDP per person). With a relatively bloated government sector, and governments falling to protesters who want even more government, it’s fourth on most Latin stock lists.
Tools of Your Trade
Latin America’s promise of growth, and its current low prices, give investments in the area a greater expected value over the long term than investments in the U.S. However, the uncertainty of return in this area is also high, and even aggressive investors should limit their exposure to the area to 5% or 10% of assets. Said investors will presumably put comparable or slightly greater sums in Europe, Japan, and East Asia, for perhaps a third of assets invested in foreign stocks.
The iShares Latin America ETF will give your clients a foot in the door down south
So where could you go to put a passport to Latin America in your portfolio? By and large, individual stocks will prove too hard to analyze or too volatile for most investors with less than $100,000 to invest in Latin stocks. The exception: A few of the largest firms may be considered for more aggressive clients who may prefer individual stocks and accept limited diversification within their Latin American holdings, presuming also that their total position in the area is under 10% of assets. For such a client, Telmex (see page 123) may be worth a look, if nothing else for its size and liquidity, as well as the growth potential for telecom in its service area.
But for most investors, the best option will be a Latin America fund. The region has a number of offerings, including exchange-traded funds (ETFs), closed-end funds, and open-end mutual funds.
We’ve covered exchange-traded funds in previous months; these relatively new securities may be the best way for most investors to purchase unmanaged index investments. For Latin America, my favorite ETF option is the iShares S&P Latin America 40 Index (ILF), which is sponsored by Barclays Global Fund Advisors. The ILF is quite new, with an inception date of October 25, 2001. That might be a problem for a managed fund, or for an untested concept, but the iShares ILF is close to a perfect market-cap-weighted index fund tracking the Latin American markets. Despite the fund’s name, it currently holds 35 different stocks, primarily American Depositary Receipts, or ADRs, in companies based in four countries: Mexico, Brazil, Argentina, and Chile. The ILF recently had 98.9% of its assets in stocks; the remainder is cash, a reflection of stock dividends, which are paid out at least annually.
With just 250,000 shares outstanding, and a recent share price of $50, the fund has a tiny market capitalization of just over $12 million. However, as one expects of an exchange-traded fund, iShares’ ILF has a low expense ratio (0.5%). Liquidity should not be a problem for most ILF investors, with a recent bid/ask spread of about 0.6%, trading volumes averaging about 5,000 shares per day, and market prices generally within 0.1% of net asset value, or NAV. Investors will be buying at a market-set price unless they can afford a 50,000 share creation unit, for about $2.5 million; the fact that institutions can create or break up ETFs in this manner does keep market prices close to NAV.
In addition to ETFs, there are other Latin American investment options. First, iShares also offers ETFs covering Mexico (EWW) and Brazil (EWZ). If you want an unmanaged single-country approach, these are the cheapest ways to get it. Furthermore, if you hold both countries, you’ll have about 80% of the region’s market cap.
The open-end Fidelity Latin America fund has been available (sold with a 3% sales load) since 1993, as has T. Rowe Price’s no-load option.
There are also multi-class Latin America funds–with front-end loads of just over 5% for A shares–offered by Evergreen, Merrill Lynch, Morgan Stanley, and Scudder.