Whilst there is significant consensus that Brazil's long-term prospects are good there is growing uncertainty surrounding the short-to-medium term outlook. Investors looking to fund managers and economic reports for clarification will find a confusing picture of conflicting reports and theories.
Performance of MSCI Brazil over 1-yr
Source: Financial Express Analytics
Previously, we reported on the inflationary pressures Brazil was facing. Henrique Meirelles, president of the country's central bank, spoke of the need for policymakers to take vigorous action to prevent the economy overheating. Interest rates were raised and government spending cut.
However, just one month on the bank has released a report saying that it has revised its view on the issue of inflation in Brazil. The report states that the domestic economy is moving towards a path more conducive to equilibrium in the long-term.
Equities tend to outperform inflation in the long-term, but the same is not true in the shorter term. However, alternative assets which are not susceptible to inflation but can provide good returns are hard to find. Index-linked bonds, for example, offer a true inflation hedge but only offer low returns so are unsuited to many investors.
Millar Mathieson, fund manager of the First State Latin American fund, is still positive on Brazil in the long term but he believes that the euphoria surrounding the country has reduced its desirability in the short-term. He takes a bottom-up approach to investment and therefore does not use monetary policy reports from the central bank when making investment choices.
"We have reduced exposure to Brazil in the last 12 months, and are not heavily weighted towards defensive stocks such as utilities and healthcare. Valuations are high and we are pretty nervous in the short-to-medium term," Mattieson said. Despite his concerns for investment in the country, he believes the government's action will be successful in keeping inflation at bay.
"With the memory of periods of hyperinflation, the policymakers have taken a pragmatic view. They have been pre-emptive, something that not many countries have been able to do."
Table showing 1-yr performance of LatAm funds
| Total Return Bid-Bid month end (31/07/2010) |
|
| Fund |
1-yr % |
| BGF - BSF Latin American Opportunities A2 USD TR in GB |
74.45 |
| Emerging Markets - Latin American Small Cap B TR in GB |
66.59 |
| Findlay Park - Latin American TR in GB |
63.2 |
| PineBridge - Latin American Small & Mid Cap A TR in GB |
61.55 |
| Santander - Latin American Small Caps A USD TR in GB |
53.84 |
| Invesco Perp - Latin America Acc TR in GB |
45.97 |
| Aberdeen Global - Latin American Equity S2 TR in GB |
44.92 |
| Threadneedle - Latin American Ret GBP TR in GB |
44.9 |
| First State - Latin America A GBP TR in GB |
44.2 |
| HSBC - GIF Latin American Equity M1C USD TR in GB |
43.48 |
Source: Trustnet.com/Trustnet Offshore (Rebased in Pounds Sterling)
Alan Ayers, emerging markets product manager at Schroders, believes that the central bank will have to take further action and rates will be continue to rise.
"It is too early to say the economy is overheating but there are inflationary concerns", said Ayers.
"However, we are positive about the situation in Brazil. In the coming months we believe that there will be anaemic growth in the developed economies with stronger growth in the emerging economies. The global economy with muddle through and in this atmosphere Brazil will continue to do well."
Schroders are taking an aggressive stance in their portfolios, choosing to be underweight in the defensive areas of utilities, telecoms and consumer staples. Instead they are overweight in financials and industrials.
"We are looking to capture the domestic side of the recovery," said Ayers.
"Valuations across Brazil generally may look a little high compared to history but fundamentals have improved, so much so the prices reflect this. It is still possible to find attractive valuations in Brazil but inflation and monetary policy are concerning."
Agnes Belaish, emerging markets strategist at Threadneedle, is also confident that the central bank is capable of dealing with any inflationary concerns.
"A highly credible central bank would take the necessary measures to entrench inflation expectations, raising interest rates just the right amount to keep inflation within targets," she said.
Chris Palmer, head of global emerging markets at Gartmore, disagrees. He does not believe that interest rates alone will be sufficient to contain inflation.
"Brazil already has very high rates of interest compared to the rest of the world. The central bank may decide to increase reserve requirements as a matter of strategy or restrict the duration of consumer borrowing.
"The problem is that there are some real capacity bottlenecks in the economy and that the economy remains vulnerable to shortages created by excess demand for a variety of items such as electricity, some specialty chemicals and building products. Wage inflation continues to be impacted by shortages of skilled workers in certain industries, for example, construction, engineering and financial services."
The picture painted here is a confusing one – fund managers differ widely in their opinions of whether there is an inflation problem and whether the central bank is dealing with any problem successfully. As a result there is no uniformity within Latin American funds in their approach to investment in Brazil – there is a broad spectrum ranging from very defensive to very aggressive.
Those invested for the short-term are likely to see fluctuating returns which may lead to the real value of their investment falling. Those invested for the longer term should remain confident that a combination of action from the central bank and a portfolio of equities will be enough for them to beat inflation.