Mexican financial markets have suffered recently from political uncertainties, both internally (newly-elected President Andrés Manuel López Obrador) and externally (the Trump administration). While these factors may impact our $3.5 billion stake1 in individual Mexican companies in the near term, the long-term structural growth opportunities for these companies should continue unabated and they should outpace Mexico's pedestrian GDP growth. But despite our focus on individual companies in the Invesco Oppenheimer Developing Markets Fund, we have spent a considerable amount of time thinking through policy priorities to address Mexico's twin principal issues of poverty and social inequality.
Following recent meetings with corporate executives and ministers of the presidential administration in Mexico City and Monterrey, we embarked on a concentrated and extensive revisit of our Mexican holdings. We also spent time as a team better understanding Mexico's history and politics. Additionally, we delved into the structural economic context of this important developing economy and its parallels across our investment universe. Conversations with Enrique Krauze, arguably the preeminent Mexican historian, were incredibly valuable in this process.
Mexico is relevant to most global investors. It is deeply integrated with the United States, in goods, labor, and capital. It is the third largest trading partner of the United States with $671 billion of trade in 20182. Mexican-Americans represent 11.2%3 of total US citizens and some estimates suggest nearly 4.9 million unauthorized Mexican immigrants lived in the US in 2017. These individuals represent the bulk of the $33.5 billion of remittances sent to Mexico last year, or about 2.7% of Mexico's gross domestic product4. Mexico is also the beneficiary of significant foreign direct investment from decades of increased integration alongside NAFTA. Tourism is one of the most important industries in Mexico. In 2017, international tourism revenue contributed 2% to Mexico's GDP5.
Mexico is amongst the most significant investment destinations for emerging market bonds and equities funds. International investors hold $346 billion6 in Mexican fixed income, which is amongst the deepest and most liquid bond markets in EM. Although Mexico's equity market capitalization of $385 billion7 is modest, it is an important source of investment opportunities for the Invesco Oppenheimer Developing Markets Fund. We have approximately 6.6% of the fund invested in seven Mexican companies8 - including the pan-Latin American retail/beverage giant FEMSA (NYSE:KOF) (OTCPK:COCSF) (2.6% of fund assets as of June 30, 2019); the mining conglomerate Grupo Mexico (1.35% of fund assets as of June 30, 2019); airport operator Grupo ASUR (NYSE:ASR) (0.46% of fund assets as of June 30, 2019); and the dominant consumer retail businesses of Alsea (OTCPK:ALSSF) (0.34% of fund assets as of June 30, 2019) and Walmex (0.5% of fund assets as of June 30, 2019). We are almost 4.5% overweight the MSCI Emerging Markets benchmark's allocation to Mexico.
Our investments in Mexico highlight our unique focus on investing in companies, not countries. We anticipate that Mexico will likely maintain pedestrian growth in GDP over the next few years, perhaps amplified by weak private sector investment following the pivotal election of President Andrés Manuel López Obrador (AMLO) in 2018 and fledgling conflicts with the Trump Administration over trade and immigration. Despite relatively tepid macro growth conditions, however, we see companies with both durable competitive advantages and the capacity to grow meaningfully. These are companies that are either oriented towards external demand (ASUR, Grupo Mexico) or able to take market share over time from inefficient (and largely informal) competitors. The MSCI Mexico index has declined 6.2% annually, or 27.2% cumulatively9, over the past five years. This weakness, in our view, has presented opportunities to invest in high-quality companies at reasonable prices.
According to Enrique Krauze, Mexico's two principal ancestral problems are poverty and social inequality. Inequality, perhaps the defining issue of global economic debates today, is deeply rooted in Mexico. Mexico has amongst the highest Gini coefficients of OECD economies. Approximately 50.6% of the Mexican population lives below the poverty line, defined as $5.4 and $3.5 per day in urban and rural regions, respectively, while 58% of the country's population works in informal sectors. Mexico's 'middle class' has remained relatively stagnant over the past decade at approximately 22% of the population. Mexico's inequality has distinct regional streaks, with a reasonably prosperous Northern and National Capital Region and largely undeveloped Southern Region.
Figure 1: Gini Coefficient*
Mexico, like many other developing economies, has a dual-track economy. There is a small and reasonably efficient formal sector, dominated by a handful of large companies across most of its industrial and consumer sectors. Alongside this is a vast pool of informal labor and micro-businesses, which are highly fragmented and extremely inefficient. One of the great investment themes in Mexico - like other developing countries - has been its companies that gain market share against inefficient, small competitors and thereby grow earnings consistently faster than the pedestrian 2-3% growth in the broader Mexican economy.
In July 2018, Mexico followed much of the rest of the world (Poland, the Philippines, Turkey, India) in electing a perceived 'populist', or perceived leader of national revival. AMLO's sweep to power, with both an overwhelming popular vote and unprecedented control of the nation's legislature, is largely a result of his close, almost magnetic relationship with the poor of Mexico and his extraordinary ability to channel their discontent and hopes for deep structural change in the socio-economic fabric. Mr. Krauze has called President AMLO a 'tropical messiah', someone who deeply embodies the collective sense of need to tackle Mexico's social frustrations - corruption, security, inequality and the absence of social mobility.
Like many populist movements around the world, there is profound concern amongst private capital about the integrity of institutions which have been built up in Mexico in its brief two decades of democratization. There is also a gnawing, and worrisome, sense of fatigue with democratic progress across Latin America - as Enrique says 'revolution was sexy, but democracy is hard'. These concerns, among others, has led to a pullback in private sector investment and considerable weakness in the Mexican peso.
The solutions: an open letter to President AMLO
As significant investors in Mexico, we have real skin in the game. And we have communicated ideas and priorities to the administration. The following are a few critical considerations, in our view.
1. Focus on execution, not ideology
The priorities are clear - improve security, fight corruption, and improve social mobility.
2. Inclusive growth is the preeminent goal
Use evidence-based solutions to figure out the most efficacious methods of improving social mobility. For instance, Mexico's current education outcomes are entirely unacceptable - this is about underinvestment, but also poor accountability. At the same time, Mexico should not give in to bad union behavior. Mexico pioneered conditional cash transfers in an effort to break the cycle of poverty. It should learn from the past and expand on conditional cash transfers to pensioners and youth-at-risk creatively.
3. Focus on boosting investments
Mexico lacks the level of investments needed to speed up economic growth and job creation. Its gross fixed capital formation as a share of GDP - at 22% - is about half of China's. Mexico's investment level also trails its EM peers like Indonesia, India, and the Philippines.
Figure 2: Gross Fixed Capital Formation
4. Fiscal investments
The role of the state needs to expand over time. Mexico simply lacks the fiscal resources to accomplish its principal goal of inclusive growth. Government expenditure as percentage of GDP (~24%) is simply too low to invest in physical and social infrastructure requirements. This is amongst the lowest in both the OECD and amongst its EM peers.
5. Private Investments
Private sector investment is critical to productivity and growth. It is crucial for the country to remove obstacles to investment and provide incentives to work alongside administrative goals (development of the South, repairing Pemex, infrastructure building, education and training).
Figure 3: Government Expenditure to Gross Domestic Product (%)
6. Promote fintech as a pathway to inclusive growth
Nearly 32% of Mexican adults have no access to formal banking services, while an additional 34% of the adult population has only one financial product10. Partnership with the private sector - like India has done - can fix this. This requires a rollout of unique identity cards to each Mexican citizen and the creation of a basic software stack, which can be adapted from India. Financial inclusion can have manifold benefits: lower payments and remittance costs; enhanced domestic savings levels, which fund capital formation (and thereby growth); permit access to capital for small businesses and entrepreneurs; greater tax collection and fiscal expenditures through greater visibility.
7. Fix Pemex
Intellectual flexibility is necessary in good governance. Pemex is the 'black swan' risk to fiscal balances, the currency and thereby growth and progress. Incentives and governance must change, the balance sheet must be de-levered (it is the world's most indebted company!), costs must be repaired, and production needs to be fixed. This will require private sector collaboration, or perhaps even investments.
8. Use your mandate wisely
President AMLO, you have an unparalleled political mandate and six years to fix many things. Focus on a few significant initiatives and be sensitive to the integrity of Mexico's reasonably young institutions, including an independent central bank and its free press. Nurture improvements in judicial independence and the rule of law, while undertaking massive reforms to improve social mobility.
1 Invesco as of 5/31/19
2 Office of the US Trade Representative
3 Pew Research Center, as of 2015, based on self-descripted ancestry, lineage, heritage, nationality, group or country of birth
4 HSBC research
5 The World Bank
6 Bloomberg as of 3/31/19
7 World Bank Data as of 12/31/18
8 Invesco as of 5/31/19
9 Morningstar as of 5/31/19
10 HSBC research
Blog header image: © Per Swantesson / Stocksy United
*The Gini coefficient is a statistical measure of distribution often used to gauge economic inequality across countries. The coefficient ranges from 0 (or 0%) to 1 (or 100%), with 0 representing perfect equality and 1 representing perfect inequality.
The MSCI Emerging Markets Index captures large- and mid-cap representation across 26 Emerging Markets (EM) countries. With 1,198 constituents, the index covers approximately 85% of the free-float-adjusted market capitalization in each country.
The MSCI Mexico Index is designed to measure the performance of the large and mid-cap segments of the Mexican market. With 26 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Mexico
The opinions expressed are those of the Justin Leverenz, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Holdings are subject to change and are not buy/sell recommendations.
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Thoughts on Mexico – parallels with rest of the world? by Invesco US
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