Seeking Alpha
CFA, hedge fund analyst, long/short equity, growth
Profile| Send Message|
( followers)  

Over the 10 years to 2010, the economies of Latin America grew by an annualized rate of 4.1% while their equity markets grew by 175% over the same period. Given the United States’ annualized growth rate of 1.7% and negative growth in the S&P500 (NYSEARCA:SPY), it's understandable that investors would be searching for higher returns.

Colombia’s stock index, the IGBC, was the fifth highest performing index followed by Bloomberg in 2010 returning 34%. Phil Poole, strategist for HSBC, predicts that Colombia could be the fastest growing country in Latin America from 2010 to 2050 and coined the term CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, South Africa) for the countries to replace the BRICS as the next big thing on investors’ screens. Colombia’s economy expanded solidly in 2010 and is expected to expand at approximately 6% in 2011- benefiting from an explosion in foreign direct investment and a favorable trade climate.

Economic Fundamentals

Colombia’s economy has been driven higher lately by strong consumer demand and improving labor market conditions. Retail sales are up 13%, and industrial output is up 4% year over year as of February 2011. Oil production, the largest beneficiary of foreign direct investment, should reach one million barrels per day this year. It is still too early to estimate the exact extent of the damages from flooding this year, but spending should be adequately covered by higher government revenue.

Colombia is one of few countries in Latin America to not be plagued by hyperinflation in recent history and, besides El Salvador, was the only other country to avoid debt restructuring in the Latin American crisis of the 80s. Inflation remains one of the government’s key economic concerns and the central bank has begun raising rates to restrict price growth. The central bank recently raised the lending rate to 4.25% while expected inflation for 2011, is approximately 3.2%. Recent decreases in global prices of commodities and economic weakness in China may persuade the central bank to hold rates steady through the rest of the year.

Colombia’s debt-to-GDP (35.7%) is higher than the average within the region, but short-term debt as a percentage of reserves is below 20%. The country has a current account deficit of $5.9 billion, or roughly 2.5% of GDP, and issued $22.5 billion in foreign debt in 2010. The government has recently approved a reform package to save excess oil and mining revenue in a sovereign wealth fund, reform the distribution of royalties to regional governments, and limit the amount of debt the government can issue.

The country continues to attract attention in the form of foreign direct investment. Colombia’s FDI reached $7.3 billion in the first quarter of 2011, an 80% increase over the same quarter in the prior year. FDI in mining and energy accounts for the vast majority of the total, at approximately 85%. The increase in FDI has been blamed for the strength in the country’s currency, the peso. The country’s currency has appreciated by 9% against the dollar in the first six months of the year even as the central bank purchases $20 million daily in the currency market to slow its rise. Despite recent capital and currency controls in much of Latin America and a vocal outcry by the nation’s exporters, the Colombian finance minister Juan Carlos Echeverry has publicly stated as late as April of 2011, that capital controls were not the answer to an appreciating currency.

The upgrade to investment grade from Standard & Poor’s, Moody’s and Fitch should bring additional demand to the country’s bonds and lower the cost of borrowing. The global economy will help determine Colombia’s fortunes through trade and commodity prices. Expected growth of 4.5% will largely be driven by emerging markets as financial problems in Europe and political noise in the United States weighs on developed market GDP. Though Colombia is a net exporter of commodities, and benefits from higher prices, persistently higher commodity prices could also have a damaging effect through imported inflation. The main effect of higher commodity prices will be a continuance of the restrictive monetary policy by the central bank.

Colombia is not without its risks, some of them particular to the country, others regional. The country has been locked in a struggle with guerilla insurgents for the last forty-six years. The Revolutionary Armed Forces of Colombia, FARC for their initials in Spanish, has seen its reach and power cut dramatically in the last eight years. In 2000, it was estimated that the group numbered more than 12,000 while it is believed that forces total less than 8,000. There are several other paramilitary groups and, more recently urban street gangs, that make Colombia more dangerous relative to other countries in the region, but the issue affects social indicators to a much larger extent than business climate. While living in Medellin for two years, I never felt any more threatened than one might in a large American city.

Colombia ranked 78th in Transparency International’s 2010 index of corruption, while the United States ranked 22nd and Brazil came in at 69th. A recent study of Colombian entrepreneurs showed that, on average, about 13% of a contract’s value is for bribery. The current president, Juan Manuel Santos, has adopted a more single-minded focus to cut corruption within the government targeting infrastructure, health services, and royalty management.

Infrastructure is a problem in Colombia, as it is throughout Latin America. The country saw less than one billion in private investment in transportation infrastructure in 2008, compared with $8.7 billion in Brazil and $260 million in Chile. The government has recently begun a drive to privatize investment in the area and has stated a goal of $56 billion in public investment over the next ten years.

Investable Asset Classes

The country’s main stock index, the IGBC, has an extremely low correlation of .2 with the S&P500 Select SPDR (SPY) since 2004. The index has returned 20.4% with a standard deviation of 25.9% on an annualized basis for the last seven years. Combining the index in equal weights with the S&P500 would have returned 11.3% and a standard deviation of only 16.5%, compared with the S&P’s annualized return of 2.2% and standard deviation of 16%.

Currently only two Colombian companies trade on the U.S. exchanges, Ecopetrol (EC) and BanColombia (CIB). Ecopetrol, the state-owned oil company with a market cap of $85.5 billion, has returned 27.2% over the last year and pays a dividend yield of 5.1%. BanColombia, one of the largest banks in Latin America with a market cap of $13.1 billion, returned 14.7% over the last year and pays a dividend yield of 2.2%. There are several exchange traded funds with Colombian exposure. The Global X Colombia ETF (GXG) is the most liquid with an average of 204,000 shares traded daily. Van Eck offers the Market Vectors Colombia ETF (COLX) and the Guggenheim Frontier Markets (FRN) holds a weight of 13.5% in the country. Foreign investors can also participate directly in shares listed in the country’s exchange, the Bolsa de Valores de Colombia through listed brokers. Recently, I wrote about the integration of the stock exchanges in Colombia, Peru, and Chile and the possible effects on liquidity and returns. Another article shows a more detailed analysis of the bond and currency market.

Taxes on Colombian capital gains are zero if the investor is selling no more than 10% of holdings within each fiscal year, otherwise capital gains taxes are 14%. Dividends in Colombia are taxed at a flat 33% rate with a credit exemption given for taxes paid. Repatriation of funds sold from Colombian equities is also subject to a .4% financial transactions tax on after-tax funds.

Clearly Colombia’s economy and investment climate are not without risks. The country faces many of the same risks chronic to Latin America and frontier markets. What diligent research will uncover is that the risks are far out-weighed by the rewards. Looking back 10 years, the countries of Brazil, Russia, India, and China were not without their own risks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Investing in Colombia: Potential Rewards Outweigh Risks