BlackRock Latin American (BRLA) has published its annual results for the year ended 31 December 2021, during which BRLA’s NAV fell by 12.5% (in US$ and total return terms), underperforming its benchmark, which fell by 8.1%. In sterling total return terms, BRLA’s NAV fell by 11.7% over the same period, while its benchmark fell by 7.3%. In comparison, BRLA’s share price fell by 11.8% in US Dollar terms and 11.0% in Sterling terms (both on a total return basis).
BRLA’s managers, Sam Vecht and Ed Kuczma, say that the performance narrative was dominated by two countries: Brazil and Mexico. Brazil, the largest constituent in the BRLA’s benchmark, detracted the most from performance, falling by 17.4%. The Brazilian market was weighed down by successive COVID-19 waves followed by higher inflation and the need for steep hikes in interest rates. Higher fiscal spending to offset economic disruption from COVID-19 put an additional burden on the already stretched debt dynamics in the country. Mexico in contrast was the standout star performer of the year, with markets rising by 22.5%. Mexico’s ability to outshine in 2021 was a function of the reopening of the economy, which continued apace as the pandemic figures (cases and mortality rates) remained under relative control combined with the benefits from a strong US recovery partially helped by the continued trend of near-shoring supply chains.
Managers’ comments on portfolio positioning and performance review
“Our positioning in the portfolio in 2021 evolved throughout the year as we looked to take advantage of attractive valuations in the region. We started the year underweight Peru while maintaining an overweight to Mexico and Brazil. As the year went on, our country positioning favoured countries with superior fundamentals determined by a strong sovereign credit profile and those economies which benefit most from the rebound in trade with US and China markets. We identified Chile and Mexico as meeting these criteria and added accordingly, while more indebted and less open economies, such as Argentina, Brazil and Colombia struggled to sustain above-trend growth we saw from the post COVID-19 recovery.
“We saw Mexico as a notable beneficiary of a growing emphasis on near-shoring and a strong economic recovery in the US. Given Mexico’s abundance of productive and relatively low-cost labour combined with a strong auto-manufacturing pedigree, we believe the country should be a beneficiary of additional investments from multinational companies who are looking to diversify their supply chains. Long overdue, large-scale infrastructure programmes in the US have increased the outlook for demand for cement production and we hold positions in one of the large Mexican cement companies which supply these needs. Over the year, we added to Mexican cement company, Cemex, and the company outperformed due to increased volumes and prices in Mexico and the United States. We also added to Mexican companies such as telecommunications company América Movil and convenience store retail company Fomento Economico, to gain exposure to Mexico’s reopening trade.
“We have also been favourable toward Chile. It has had one of the highest vaccination rates in the world, with over 90% of the population receiving at least one jab by year end 2021 (Source: Our World in Data, 2 January 2022). This has allowed a strong economic recovery, that the Company accessed through exposure to banks and department stores in the region. As the December 2021 presidential election created some volatility in the short term, we took the opportunity to add to the Chilean department store chain, Falabella, given the company’s position to benefit from this gradual economic reopening and improving consumption trends.
“Over the year we also added to Copa Holdings, a Panamanian airline, as we believe pricing power has increased. The company is navigating through the COVID-19 crisis well and we believe it will end up in a better competitive position given that multiple regional competitors are going through financial restructuring. The company is well positioned for return of demand to underserved markets with limited substitutions for air travel.”
Managers’ comments on current portfolio positioning
“As in 2020, the portfolio ended 2021 with its largest country overweight in Mexico.
“Looking forward after outperforming for much of the year, valuations are not as discounted in Mexico today as they are in other countries. While Argentina shows as a regional overweight, the Company holds a single holding in the country through IT consulting company, Globant. We like the company for its rapid revenue growth with expanding margins and a strong set of accelerators that leverage Artificial Intelligence and other technologies to reinvent key aspects of organisations.
“The portfolio started off and also ended, the year with a slight overweight to Brazil. There is considerable uncertainty ahead of the November 2022 election and some strains are appearing in the public finances. That being said, we are finding plenty of opportunity at the individual stock level. We are looking at traditional banks and insurance companies that should be beneficiaries of rising interest rates. We also see opportunities in healthcare, as countries aim to rectify the weaknesses in their health infrastructure exposed by COVID-19. Over the year we added to Rede D’Or São Luiz, a Brazilian healthcare company. The company’s earnings momentum remains strong as it accelerates its leadership position through both organic expansion and acquisitions in a market with attractive long term growth opportunities. We also initiated a position in XP Inc, a Brazilian investment management company, as we continue to see the company taking share of wallet from incumbent banks. The company has an attractive mix of profitable growth and continues to display operational momentum from scale gains. Similarly, we added to B3, the Brazilian stock exchange, on the back of resilient growth in cash flows which will benefit from continued maturation of the domestic equity market as the country remains on the path of a broadening and deepening of financial markets.
“Throughout 2021, and up to the date of this report, the Company did not have any exposure to Colombia. Colombia is highly dependent on oil (exports, fiscal revenues, index exposure) and has a fiscal deficit that is very likely to worsen from here if structural reforms are not enacted. As we get closer to the presidential election in the second quarter of 2022, we expect the equity markets and the currency to face volatility where we may see an opportunity to reexamine our exposure at more attractive valuations.
“At the sector level, we are overweight financials and real estate, and underweight consumer staples and energy.”
Managers’ comments on outlook
“A void in critical materials, both hard and soft commodities, has emerged in the wake of the Russia/Ukraine conflict, turbocharging an already supply-constrained global commodity backdrop. The quest for alternative suppliers and modified value chains has been kicked into high gear. Latin America is well situated to fill this gap given its abundance of natural resources. History has shown that strong raw material prices shine a favourable light on Latin American equity markets considering that in the last three commodity booms (since 1999), Latin American equities rose by an average of +203% (Brazil +287%). Additionally, when looking at 2002 (when China entered the World Trade Organisation) to the global financial crash in 2008, Brazilian stocks returned +672%. Despite the surge in commodity prices since March 2020, Latin American stocks have lagged due to subpar growth, political uncertainty, fiscal challenges and devastating COVID-19 waves. Conversely, the region trades at the widest discounts to historical multiples (Price to Earnings ratios, Price to Book Valuation, Enterprise Value to Sales ratios, EV/EBITDA (Earnings before interest, tax, depreciation and amortisation)) relative to Emerging Market peers (–1.4 standard deviations on average vs –0.1 for Asia-X, –0.6 for CEEMEA (Central and Eastern Europe, Middle East and Africa)). We would argue given current natural resource prices, commodity economies in the region are no longer ‘fragile’ given competitive currency exchange rates, current account surpluses, manageable deficits and large foreign currency reserves. We see scope for a growth and equity performance catch-up, especially if China reflates and/or signals for monetary ease.
“Brazil is by far the largest, deepest and most liquid Emerging Market exposed to a new commodity supercycle. We acknowledge risks of soaring inflation in an election year, but we believe these concerns are largely offset by:
- a major positive shock to terms of trade;
- Brazil indices are packed with big and liquid commodity stocks (44% of MSCI Brazil);
- the Brazilian central bank is ahead of the curve in its tightening cycle (liftoff was in March 2021), which saw rates moving from a historical low of 2% to 11.75% as of end of the first quarter of 2022;
- Brazil has historically rallied during periods of tighter US monetary policy (+57% IBOV average US Dollar returns in the first year of Federal Reserve hikes, dating back to 1998); and
- the Brazilian Real ended 2021 as undervalued and can boost hard currency-denominated returns (historical appreciation of +18% in first year post the Federal Reserve initial hike). Brazilian stocks are also benefiting from a surge in commodity prices and Russia’s exclusion in benchmark Emerging Market indices, as well as hopes that the winner of October’s presidential election will not derail the nation’s economic policy.
“While there remain a number of economic and political challenges for Latin America in 2022, we believe many of its troubles should be behind it. The interest rate cycle may start to turn as inflationary pressures ease in the back half of 2022 following spikes early this year. The global economic recovery should create continued demand for natural resources, which Latin America has in abundance. Vaccination rates across the region are also high, and companies have grown more adept at dealing with mobility restrictions. We believe all these factors should allow for stronger economic growth in the years ahead. At the same time, we believe valuations are attractive. By global investment standards, Latin America is highly under-owned and rising interest rates have done little to improve its popularity. Higher rates have also taken some domestic equity investors out of the market as yields in fixed income have risen. However, we see the opportunity for this trend starting to reverse in 2022. Entering the year, expectations are low for Latin American equities, but there are many great companies benefiting from rapidly changing factors which can positively impact the region. We believe the future may be more positive than many expect.”