This is the 12th piece in Seeking Alpha's Positioning for 2013 series. This year we have taken a slightly different approach, asking experts on a range of different asset classes and investing strategies to offer their vision for the coming year and beyond. As always, the focus is on an overall approach to portfolio construction.
Caiman Valores (See Seeking Alpha's policy on anonymous authors) is a Colombia-based independent investment analytics and risk management consultancy specializing in South American equities, regional macro-economic trends, and risk assessment. The consultancy is based in Bogota, Colombia.
Seeking Alpha's Jonathan Liss recently spoke with Caiman Valores to discuss Latin America's macro-economic outlook and evaluate individual investing opportunities on the continent as we begin a new year.
Jonathan Liss (JL): How would you describe your investing style/philosophy?
Caiman Valores (CV): I am a value investor focused on company fundamentals with a macro overlay. For example when analyzing Latin American banks, I like to thoroughly examine their asset quality, financial performance and performance indicators, while also looking at growth opportunities created by the economy in which they operate. This also applies to FMCG companies like Arcos Dorados (ARCO) and Telcos such as Telefonica (TEF), particularly as regional demographics heavily influence the growth of market share for these companies.
JL: As we approach 2013, are you bullish or bearish on Latin American equities?
CV: I am quite bullish on Latin American equities as a whole, despite the problems in Brazil. Political risk will remain high, particularly in Brazil, Argentina, Bolivia and Venezuela. Investors will also need to understand the key economic and risk drivers, with stock picking being key.
JL: What are the major catalysts for Latin American equities in 2013?
CV: Key catalysts include:
- A gradual improvement in the U.S. economy, with that country being a major trade partner for the Andean countries like Colombia.
- An economic recovery in China, which will drive further demand for commodities from the region, particularly iron ore and copper.
- An improving security situation in Colombia will mean increased oil and gas exploration as well as additional foreign investment, further fueling the remarkable Colombian growth story.
- Increased foreign investment, with the U.S. still having a zero interest rate environment.
- Changing demographics in the region resulting from greater global economic engagement and increased wealth. This will boost the growth of the middle-class and further boost domestic consumption particularly in Chile, Colombia and Brazil.
CV: I believe Latin America's longer-term outperformance will continue for at least the medium-term because so many countries within the region are still decoupled from the mainstream global economy and have significant growth potential. But as these economies grow they become more closely coupled to the global economy as we are now seeing with Brazil and Chile.
The outperformance is based more on these economies being significantly less developed and then obtaining the necessary resources, expertise and capital to develop. This sees a surge in development as they become ‘catch-up’ economies that gradually fades as they further develop. This growth then stalls when they have reached the high-middle income point unless the country has the ability to transition to a high income economy.
Therefore, it is essential for investors to understand the correlation between economic development and investment returns, although rapid economic growth is no guarantee of solid investment performance.
Other drivers of this outperformance will continue to be demand for the region’s resources from a booming China and a gradual growth in the middle-class in the region, which will boost consumption. This we are already seeing with the recent surge in the price of iron ore and subsequently Vale’s (VALE) stock price.
JL: As we begin 2013, what is your highest conviction pick?
CV: That is a difficult question to answer because there are a number of companies that I am bullish on, but if I had to choose one stock it would be YPF. I believe that the company has been significantly oversold on sentiment relating to the behavior of the Argentine government and the growing political risk in the country. I also believe that in the case of YPF this has been overplayed by pundits and we are already seeing that with the company finding investors for its shale oil and gas fields in the Vaca Muerta.
JL: Which country or countries are you avoiding at present and why? Which countries are you most bullish on as we head into the new year?
CV: I am avoiding Venezuela and Bolivia. I had originally put Argentina on that list, but while it is extremely risky I believe that there is some value there and the political risk is not as heightened as some pundits would have investors believe. I am also concerned by the increasing political and economic risk in Brazil and again while I am not avoiding the country, investors need to be aware of this risk.
The key reasons for this view are the high levels of political risk in those countries combined with a recent history of erratic and highly interventionist government policies. There has been a significant resurgence in resource nationalism and populist politics in those countries. I am also quite reluctant to invest in Mexico, although I am not avoiding the country, with the ongoing security issues, narco-trafficking conflict and high levels of corruption.
I believe that there are significant deep value opportunities emerging in Argentina and growing opportunities in Brazil for those investors with a high tolerance to risk.
I am most bullish on Colombia and Chile. It is my belief that Colombia currently offers the biggest opportunity for investors, particularly with the latest round of peace talks indicating the security situation is further stabilizing. This will see further oil and gas exploration and reduce the likelihood of production outages from oil pipeline attacks that were impacting the production and revenue of Ecopetrol (EC) and the midsize and smaller players.
The problem with Colombia as an investment is the lack of U.S.-listed investment options, with only two companies with U.S. listed ADRs, Ecopetrol and Bancolombia (CIB), as well as two ETFs, Global X FTSE Colombia 20 ETF (GXG) and Market Vectors Colombia ETF (COLX).
Investing directly in Colombian stocks through the Colombian Exchange is worrying at times, because of its generally low levels of liquidity and ongoing issues around insider trading. This is why I prefer U.S.-listed ADRs.
Chile is an interesting investment location. It is stable, has solid regulations and low levels of corruption coupled with a particularly strong banking and finance sector. I especially like Banco Santander’s (SAN) Chilean subsidiary Banco Santander Chile (BSAC), which continues to perform strongly. I believe investing in Chile is an important addition to any investor's portfolio, providing geographic diversification along with access to probably the most advanced economy in Latin America.
JL: How important are demographic trends in reaching your overarching investment thesis? How do demographic trends look in Latin America from an investing perspective? Which industries/countries stand to do best based on your reading of current demographic trends?
CV: Demographic trends are very important in Latin America and I don’t believe that many pundits understand this. It is easy to see the high levels of growth, particularly in the size of the middle-class in the region and increasing consumption. I believe that this will continue to drive economic growth.
There are significant structural demographic and economic issues within the region’s economies, the key ones being that these countries are export-based economies with a very unequal distribution of income and wealth which means they don’t have the same broad-based consumption patterns of developed economies. They also have relatively low average incomes and therefore can only carry relatively low private sector debt to GDP ratios. This caps the level of consumption and the ability to grow private sector credit, which forms the basis for the developed domestic consumer economies. This is probably best reflected in the inability of Telefonica (TEF) to tap the huge Brazilian market and build decent margins, with many consumers simply unable to afford high end (high margin) products.
JL: For U.S.-based investors looking for Latin America exposure, both via broad regional ETFs as well as single country ETFs, which would your top choices be? Any funds you would specifically avoid?
CV: That is another difficult question to answer because I generally prefer to not invest via ETFs. My bias is to invest directly through individual stocks and my preference is for high conviction concentrated portfolios. But in the case of countries such as Peru and Colombia, an ETF is the only choice for most U.S. investors if they are to obtain broad-based investment exposure.
My top choices for ETFs at this time would be Colombia ETFs, of which there are currently two: Global X FTSE Columbia 20 ETF (GXG) and Market Vectors Colombia ETF (COLX). I prefer COLX over GXG despite GXG having performed more strongly in 2012, having a much greater AUM, and also greater average daily trading volume (making it potentially more liquid).
- It has broader-based exposure to the companies listed on the Colombian stock market, the Bolsa de Valores de Colombia or 'BVC'.
- It has a slightly lower expense ratio, 0.75% vs. 0.78% (I know it's a marginal difference, but every dollar counts when investing in broad-based managed investment vehicles).
- It caps all holdings at 8.5%, which creates greater diversification and potential exposure to smaller Colombian companies, without leaving investors overexposed to Colombia's two largest companies, Ecopetrol and Bancolombia.
I also like the iShares MSCI Chile Index ETF (ECH) and the iShares MSCI All Peru Capped Index ETF (EPU). As mentioned earlier I believe that Chile is highly underrated by investors and will continue to experience strong economic growth despite its dependence on commodities exports, partly due to its stable political and economic environment combined with strong domestic demand, and coupled with a mature financial services sector.
I believe that Peru will also provide strong gains for investors but the lack of maturity in Peru’s domestic economy combined with emerging political issues and economic risk is of some concern. This is exacerbated by its overreliance on commodities to create economic growth combined with an immature financial services sector and domestic consumption patterns. EPU performed strongly in 2012 and that performance could fade away somewhat if the issues discussed continue to gain traction. President Humala's (mis-)handling of those issues, particularly regarding the re-emergence of the Shining Path Communist Party along with social unrest regarding a number of mining developments definitely raises legitimate concerns.
A good compromise ETF for investors seeking broad-based exposure to the Andean region is the Global X Andean 40 ETF (AND). This ETF gives investors broad-based exposure to major companies in the three Andean economies of Colombia, Peru and Chile and is a useful one-stop shop for portfolio diversification, which is handy for retail investors.
Disclosure: Caiman Valores is long EC, CIB, YPF and may take a long position in VALE.
To read other pieces from Seeking Alpha's Positioning for 2013 series, click here.
