After a challenging 2018 for emerging markets broadly, Aberdeen Standard Investments’ Devan Kaloo is expecting more positive performance this year from Latin America and one country in particular.
Kaloo, head of global emerging markets at Aberdeen Standard investments and a manager on the £120.9m Aberdeen Latin American Equity fund, said many of the factors that worked against emerging markets last year could reverse in 2019.
“We think that the US dollar is going to be back down again this year and that is a good environment for emerging markets and Latin America,” he said.
“It’s going to be down because US growth has been accelerating away from the rest of the world, inflation has tamed and deficit acceleration is not dollar-supportive. Therefore, it’s hard to see how you get a stronger dollar.”
As the below chart shows, the US dollar has risen by 4.73 per cent against the Swiss franc – immune from the challenges facing the euro and sterling caused by Brexit – over the past year.
Performance of US dollar in euro over 1yr
Source: FE Analytics
The second major factor is reflation in the US, with tax cuts and low unemployment rates likely to encourage consumption this year. Such recovery growth would be positive for Latin America, said the fund manager, given the importance of the US consumer goods market and the role played by the commodities sector in the region’s economies.
Finally, Kaloo said there was likely be a resolution to the US-China trade dispute that dogged emerging markets last year and continue to cast a shadow over global growth.
“The economic consequences of not doing so are pretty dire, not just with regard to both those countries, but global growth more generally,” he explained. “You could get quite a negative spiral if there was a global trade war. As a result, we think a deal will be struck.”
Within emerging markets, however, Kaloo is most positive on Latin America, which has suffered disproportionately compared with other emerging market regions because of the Federal Reserve’s tightening regime, which has recently been put on pause.
“Latin America is the most sensitive to US interest rates, so the fact that they’re not going up probably means that it’s going to be one of the largest beneficiaries,” the fund manager said.
“When the US started tightening and went from QE [quantitative easing] to QT [quantitative tightening], it was pretty tough on all emerging markets. But growth in Latin America was probably worst hit.”
He added: “There were domestic reasons, which made that worse – particularly in Brazil – but, economically speaking, it’s been one of the worst performing regions.”
As such, Kaloo said it’s the region with the biggest upside with regards to economic growth recovery and that has started to be seen among corporate earnings.
Yet there is one country in the region that is likely to surpass the others in 2019: Brazil.
Having not quite lived up to its potential as political scandals rocked the country in recent years, the election of a new president has been welcomed by the market.
Right-wing politician Jair Bolsonaro was elected president late in October 2018 and took office at the start of the year.
As it became clear that Bolsonaro would likely win the presidential election ahead of the first round in September, the Brazilian market began to respond positively. Over the past year the MSCI Brazil index has risen by 10.07 per cent – in sterling terms – outpacing the 3.48 per cent gain recorded by the broader MSCI Emerging Markets index.
Performance of indices over 1yr
Source: FE Analytics
“Brazil is probably the most interesting story, because it has elected a [political] outsider who has socially conservative views. That would perhaps be a step backwards, or more than one step, but economically he is very liberal and in fact if he was to execute on the various policies he has put forward then that would be viewed as positive for Brazil’s economic growth,” said the emerging market equities head.
One of the biggest reforms the new president has campaigned for is pension reform, which previous governments have failed to secure and is likely to become a question of affordability in the near future. Kaloo said that Bolsonaro also wants to improve competitiveness and reduce the role of the state within the economy and privatise assets.
“Support for him within the country is of support for change, his previous incumbents had not done well and left-wing policies had not done great and as a consequence they were willing to give him a go,” said Kaloo.
“I would urge a slight note of caution that as an outsider who was not expected to win he doesn’t have the largest party in congress and has to build a coalition to get these reforms passed, which makes the execution of it tougher.”
As such, Kaloo favours businesses that are potential beneficiaries from economic reform and growth within the four FE Crown-rated Aberdeen Latin American Equity fund, albeit those that fit with the manager’s quality bias.
“We’re looking to invest in companies with strong management teams, good cashflows and strong balance sheets,” said Kaloo. “The reason we always want to be protected on the downside because we don’t know when the proverbial will hit the fan.”
Companies such as Brazilian bank Bradesco fit the bill, according to Kaloo, which has experienced strong credit growth improving performance of non-performing loans.
Another company is Brazilian car rental company Localiza
“Localiza is a car rental company that has a big used car sales arm, and they consolidated in the downturn in the Brazilian market and as the economic recovery comes through they will be big beneficiaries,” he said. “They’ve also benefited from the rise of Uber and other car sharing companies. So, there is a lot of interesting dynamics and it is an extremely well-run company.”
The Aberdeen Latin American Equity fund is included in the FE Invest Approved List with analysts highlighting the team’s stock selection approach and quality bias, as well as the importance placed on corporate governance.
“The fund has generally outperformed the market through superior stock selection, except for the year following the ‘taper tantrum’ of spring 2013,” they said. “The fund’s large position in Brazil hurt as the economy declined, although the managers maintained their holdings as this was where they found quality companies.”
The portfolio has a 63.6 per cent weighting to Brazilian equities and includes several within its top-10 holdings, including Itau Unibanco – the largest position at 9 per cent of the portfolio.
Performance of fund vs benchmark since launch
Source: FE Analytics
Since launch in October 2012, the Aberdeen Latin American Equity fund has made a 16.48 per cent total return compared with a 3.06 per cent gain for the MSCI Emerging Markets Latin America 10/40 benchmark. It has an ongoing charges figure (OCF) of 1.19 per cent.