abrdn Latin American Income (ALAI) has published its annual results for the year ended 31 August 2022. During the period, ALAI’s net asset value (NAV) rose 6.8% in total return terms over the year, compared with an increase of 11.5% for the benchmark. The share price was broadly flat over the period, ending the year at 52.25p. This relatively weaker overall performance was primarily due to the weaker performance of the equity sleeve of ALAI’s portfolio, which returned 3.34% versus the index’s 10.79% gain. This underperformance was attributable to the equity market shift away from growth stocks, that had proved relatively robust during the pandemic, towards value. Unfortunately, this market rotation undermined the Company’s strategic longer-term focus on quality growth stocks.
In contrast, ALAI’s fixed income exposure did better. A large overweight exposure to Uruguay had a major positive contribution to relative performance, as did the lack of any exposure to Chile which, together with Colombia, significantly underperformed other regional markets. Uruguay’s good performance was attributable to a strong soybean harvest, which is a key export for the country. Additionally, rising food prices helped the Uruguayan peso outperform its neighbours over the period due to its position as a major exporter of beef. Meanwhile, Chile, one of the world’s top copper producers, struggled over the year due to lower copper prices. A severely weakened Chilean peso alongside a stronger US dollar also negatively affected the country’s performance, despite a US$25 billion intervention by its central bank that had aimed to quell exchange-rate volatility. Colombia also had a difficult year, as the country’s July inflation number was 10.2% year on year, which was its highest reading in over a decade. The Colombian peso was also weighed down by the interest-rate hikes from the Fed and the strong US dollar, along with a growing import bill and profit remittances from commodity companies operating in the country but actually based outside.
Market backdrop
Latin American markets rallied over the review period, which was marked by intensifying price pressures as the region, and the world, began its post-pandemic recovery, which were intensified by Russia’s invasion of Ukraine. The ensuing sanctions on Russia’s export of oil and commodities led to the prices of these resources skyrocketing. By March, a month into the invasion, oil prices had soared to their highest levels since 2008. This turned out to be a boon for resource rich countries in Latin America, in particular Brazil and Chile, which boasted double-digit equity returns for the period. At the end of the Company’s financial year, Latin American stocks had outperformed all other equity markets outside of the Middle East oil-rich region, thanks to the stellar performances of the region’s energy and commodity companies.
However, while Latin America’s miners and energy producers benefited, spiralling fuel prices hit the everyday consumer hard, driving food and travel costs too high, too quickly. The reaction from central banks, was to limit liquidity in the market by raising interest rates, with Latin American central banks ahead of their peers in this respect. ALAI’s manager says that, as a result, while most equity markets in recent months were rocked by the US Federal Reserve’s aggressive rate increases, Latin American stocks were far more resilient, having already priced in monetary tightening since late 2021 and even earlier for Brazilian equities. According to the manager, at the time of writing interest rates in Brazil, Chile, Colombia and Mexico stand at 13.75%, 11.25%, 11% and 9.25% respectively, compared to other emerging markets like India (5.9%), Indonesia (4.75%) or Poland (6.75%), for example.
On the downside, the evolving domestic political landscape has been a drawback for investors. Major political events in Chile, Colombia, Peru and Argentina led to investors taking a more cautious approach towards these regional markets. The manager says that there has been a palpable change in the political tide, as dominant right-wing parties were voted out in favour of leftist, socially-oriented leadership in Chile and Colombia. This led to capital flight, putting pressure on the currencies and the bond markets. Meanwhile, Brazil’s presidential elections have been intense and have left investors uncertain. Lula won 48% of the votes against Bolsonaro’s 43% but fell short of the clear majority of over 50% of valid votes required to prevent a run-off. He eventually secured his lead on 30 October, with 50.9% of the votes against Bolsonaro’s 49.1% and the transition process for the new president-elect has begun. Overall, despite these bouts of uncertainty and sporadic market weaknesses, Latin American stocks generally had a robust year and emerged top of their asset class.
Attribution
ALAI’s exposure to companies linked to dynamic growth themes, such as ecommerce, digitalisation and renewables were punished by the steepening of yield curves across the globe. As such, the portfolio’s exposure to XP Investimentos, which is the largest brokerage firm in Brazil, detracted, as did its exposures to renewable energy producer Raizen, and software services provider Totvs. Additionally, Sequoia, which largely benefited from the increased demand in ecommerce-related logistics, massively corrected on the back of concerns over slowing global growth and its impact on this ecommerce demand. Sequoia’s share price was also hurt as its margins were shrinking due to higher-than-expected operational costs, in particular, from the cost of diesel. Over the year, ALAI’s holding in XP and Sequoia were exited, but the manager kept the exposures to Raizen and Totvs, which are well thought of stocks, that it thinks will benefit returns in the longer term.
In terms of the portfolio’s performance by sector, the lower exposure to the energy sector detracted the most. While ALAI’s exposure to Brazilian state-owned petroleum producer Petrobras added to overall returns as prices soared, the underweight exposure compared to the benchmark once again hurt relative returns. Petrobras rallied amid the surge in crude oil prices, and investors were doubly enthusiastic when the company announced record dividends. Investors were also optimistic about the talk of possible privatisation of the company following a new business plan that stressed capital discipline and a commitment to dividends. Although the manager gradually increased ALAI’s exposure to this stock over the second half of the year, the fund’s underweight exposure negatively impacted the portfolio’s relative performance. More positively, the exposure to Geopark, which is an off-benchmark holding, helped. The Colombian oil and gas explorer did well over the period and lifted performance. The company also cheered investors by increasing its quarterly dividends for the third time in a year.
Elsewhere, the exposure to materials stocks was mixed. Brazilian miner Vale was the top contributor, as the company’s shares recovered from the weakness in iron ore prices seen at the start of the year and rose in tandem with other commodity producers in the region. ALAI’s lack of exposure to Mexican building materials company Cemex was also a positive with the company lagging the benchmark over the period. However, not holding Chilean miner and fertiliser producer SQM proved costly, as investors remained bullish on the prospects for lithium prices due to rising demand levels.
ALAI also benefited from not holding cosmetics group Natura & Co. and from the underweight to Magazine Luiza as the stock was exited during the year. The exposure to footwear retailer Arezzo also proved beneficial.
Portfolio activity
The key portfolio changes on the equity side centred around the holdings in Brazil, and the manager’s attempt to reposition the portfolio against the downside risks of shrinking domestic consumer demand due to inflationary pressures. Several consumer discretionary holdings were sold, such as fast food franchise BK Brasil, clothing department store Lojas Renner, retail chain Magazine Luiza and ecommerce retailer Mobly. The Chilean shopping malls’ operator Parque Arauco was also exited on the back of the more challenging outlook for discretionary spending. Instead, ALAI gained exposure to Assai, a leading cash and carry Brazilian retailer that the manager thinks is well-positioned to capture consumers’ changing habits. The manager thinks this was achieved at an attractive valuation.
The manager also sought to reduce exposure to growth stocks that were punished by the market rotation brought about by steeper borrowing prices. Names such as education software firm Arco and online services platform GetNinjas were exited in favour of better opportunities elsewhere, as well as selling Sequoia and XP, as mentioned earlier.
While there has been a traditional focus on high-quality growth stocks as the manager sought to tap into the demographics of the region (a large and growing middle class), it has simultaneously kept an eye on high-quality value stocks. For example, Telefonica Brasil, was introduced during the year. The manager had been cautious about the sector due to its capital intensity and a stringent regulatory environment, but decided to introduce the holding as it believes that Brazilian telecommunications will benefit from an improving competitive and regulatory environment. Earlier in the year, the manager introduced three other value stocks, including junior exploration and production company 3R Petroleum, Peru’s leading banking franchise Credicorp, and vertically integrated pulp and paper producer Klabin. These acquisitions were funded through the sale of ALAI’s sub-scale positions in renewable energy holdings, Omega and Weg.
On the fixed income side, the manager took a more defensive approach in the face of rising inflation, in the first half of the year, reducing the portfolio’s duration exposure in Brazil, Mexico, Peru and Uruguay. Towards the end of the financial year, the manager cautiously started adding back longer-duration bonds to the portfolio as the monetary policy tightening cycles matured and it observed what it considers to be the peak of the inflationary pressures.