In this podcast we are joined by the Trust managers, Viktor Szabo and Brunella Isper. They give an update on the Trust's performance over the last six months and current positioning. They also provide a macro update and consider the risks and opportunities across the region as we move into 2022.
Recorded on 17 November 2021
Discrete performance (%)
Total return; NAV to NAV, net income reinvested, GBP. Share price total return is on a mid-to-mid basis. Dividend calculations are to reinvest as at the ex-dividend date. NAV returns based on NAVs with debt valued at fair value. Source: Aberdeen Asset Managers Limited, Lipper and Morningstar. Past performance is not a guide to future results.
Interviewer: Hello, welcome to the latest in our abrdn Investment Trust podcast series, where we catch up with our investment trust managers. Today we welcome Brunella Isper and Viktor Szabo, managers of the Aberdeen Latin American Income Trust to discuss what's happening in Latin American markets today. Welcome Brunella, welcome Viktor. Viktor, if we could start with you, how is the recovery looking across the region? I mean, do you believe that most Latin American economies are now on a sustainable path to growth?
Viktor: Hi Cherry, and thank you for the invitation. Well, what we're seeing is that economies continue to recover. After the pandemic, we have seen decent growth rates in the second and third quarters of this year, which is little surprising given that both monetary and fiscal policies remain broadly supportive. It is also good news that vaccination is progressing in the region quite well. If you look at the outperformers, Chile and Uruguay, they have about three fourths of their population fully vaccinated. Brazil and RG are about 60%. And even the relative laggards you know, Peru, Mexico, and Colombia have around half of their population fully vaccinated. So overall, the region is above the emerging market average. And they are doing much better than many European or Asian emerging market countries. I mean, obviously, there's still some headwinds, remaining disruptions in the global supply chains are clearly a headache for some countries, we have seen quite poor growth data from Mexico. And I suspect that the semiconductor shortage, which we see globally, has really hit their automobile production. That's one of the main reasons why we're seeing that disappointment. But more generally, the high commodity price environment is favourable for the region. And we hope that basically, countries now learn to live with COVID. And that's going to be less and less impacting their economies.
Interviewer: I mean, one of the big headline actions of the past few months has been Brazil announcing a reasonably chunky rise in rates in October. Can you give a little bit of the background to that, Viktor, and talk about what that's done to bond markets?
Viktor: Yes, sure. So what we have seen over the last few months is that inflation continued to rise over and above expectations. And it's not just a Latin American phenomenon, I mean, monthly inflation rates have been elevated around the globe, and that includes developed market countries in the last few months. It is fact that Brazil brings one of the highest inflation there, CPI moved to double digits for September, October print was 10.7%. Probably we are seeing the peak in Brazil, though it's still at a higher level than the central bank or the markets have anticipated. And as an emerging markets country, Brazil has no possibility to just sit on their hands, the monetary policy has to react to these high inflation brains, to stop them from spilling into inflation expectations, because then it will be more difficult to bring inflation down. So as I said, it's not just Brazil phenomenon, or the central banks in the region have hiked, with no exception. But it is true that Brazil has been hiking with the fastest pace. Although we must also keep in mind that Brazil had been cutting the fastest space before the pandemic and as a reaction to the pandemic. So the rates in Brazil have reacted to high inflation but also to the reemergence of some fiscal risks. There was a significant increase in a court mandated payments for next year, basically eating up all the discretionary spending space for the government. And the administration had to react. And it is in a very difficult spot, especially at a time when the President's popularity is falling. And he's quite keen on stopping that decline in popularity by extending social benefit programmes. The famous Bolsonaro rebranding, giving larger handouts to more people. And quite clearly the markets are concerned with a potential fiscal deterioration. So for that reason, we have seen quite a sharp rise in Brazil, which started to moderate a bit over the last couple of weeks.
Interviewer: Okay, thanks Viktor, Brunella bringing you in here. What's that done to stock markets, I mean, they've been feeling the impact either of recovery or of rising interest rates?
Brunella: Hi, Cherry, thanks for the question. So in the equity markets, I guess the effect of all the comments that Viktor made are largely threefold if we want to summarise. So if we talk about the rising rates, so firstly, the direct impact, the more direct impact to companies on the ground is that we see the cost of debt rising, and that directly impacting the profitability of companies. So that's seen negative. Also, the one step back if we see why rates are rising is because inflation is high. So that also impacts profitability of many companies, especially those which don't have much pricing power. And where you see them, seeing that pressure buildup in their cost base as GNA, gross margins, etc. So that's, that's the direct impact on companies then if we if we look at valuations, for example, the impact is that we see the repricing of assets for the higher cost of capital in the region, right. So you have those stocks, which have a longer duration cash flow profile, or growth stocks, where most of their values in perpetuity, when we bring that present value at a higher rate that sees the fair value of companies declining. So hence why we also see downward pressure on asset prices. So equities in general, in the region. And in particular, in Brazil, where we're seeing this more rapid rate rise, we're seeing quite a sharp correction in equity prices. And then thirdly, and last comment is just that, as we see rates rise, we do see the beginning of a shift between asset classes between coming from equity, which was on the rise, right, because interest rates in Brazil had been as low as 2%, which is record low historically. So there was a lot of incentive for all the market to put more allocations into equities. So now we see some of that shifting back towards fixed income and other asset classes. So I don't think that the current level is too low in historical standards. So this is not yet a major driver, but just something that we keep on the radar. But I guess the first two points are perhaps the most important and what explain that the recent correction in Brazil on top of, of the rising fiscal concerns, as Viktor mentioned, and not least because of the political risks of elections next year, which we should talk about more later on.
Interviewer: Okay, and sticking with you, Brunella. And zooming in on the trust. And how has that performed over the last six months? Have there been any sort of noticeable winners or losers? Have you have you managed to sort of steer a path through this quite difficult environment?
Brunella: Yes. So we have the trust over the past six months, if we look at the performance of the NAV in gross terms, was nearly flat. So actually, there was a period of good performance or positive performance, and that has given back over the past months, because of all these effects we've been talking about in Brazil, but also across the region, I guess, beyond the improving external environment and the rising commodity prices, which naturally for the region should be quite positive, right for both asset classes. I guess the local effects and the domestic events have actually overshadowed that, unfortunately. So I would say election outcome improved, for example, or in Brazil, all these events were talking about in Chile, we also had concerns around the creation of the Constitution commission, and also concerns around elections, which are which are coming up recently, I guess all these events brought volatility to the region. So actually, while we have seen equity markets, globally, quite positive. If you look, for example, at MSCI World in the period in last term, the market has lagged. So the trust in the period has declined point 9% and that compares to the benchmark return of 1.3%. So there was around 2% and the performance if we look at that broken down, actually we had a slightly higher allocation to equities when compared to the benchmark. So we had a bit of a overweight to equities in the period at the end of September that set around 62% versus benchmark at 60%. So having more equities at a time when equities were out of favour, was one of the laggards when we talk about relative performance. And then on the flip side, when we talk about positive things is really that the fixed income sleeve performed quite well, compared to the benchmark. So I guess Viktor can maybe talk more about later, but I think are underweight or no exposure to Chile was quite positive, because of the significant under performance of that market in the period. And then secondly, or perhaps the most important point to flag in terms of contributors to performance in the bond sleeve is our positioning in Uruguay, which has done extremely well over the period. And in particular, when you compare it to the region, right, then talking about equities. So on the equity side, things haven't worked out as well for us. The equity markets over the past six months, had a positive return of just under 3%. While the fund declined about 3% in the period, so we had a negative impact from our stock selection in Brazil, and Chile. And then if we look down a bit further things which have contributed to that, for example, is holding a few stocks in Chile, for example, Parque Arauco operator, which has been suffering, even though the reopening is occurring, it's taking perhaps a bit longer, and also political concerns around the region where the company has its main assets. So Chile, Peru, and Colombia, has also led to an underperformance in in shares of that company. Then other the things like Santander Chile, where we have exposure, it's also been a laggard in the period. And holding Sequoia, which is a logistic group in Brazil. One of the factors which drove the underperformance is partly down to that inflation impact to earnings and the revaluation of the company's fair value, but also being a high growth company and how rising interest rates also impact that the perception of value of such company, not least because it's a small cap, and a theme that we have seen over the period is that small cap stocks have been more beaten up in this downward market move in in the equity markets in the region. So I would flag those as I mean that the main highlights of performance for the past six months and in September.
Interviewer: Let's move on to your current positioning Viktor. I wonder if you could start with that and just talk both about the relative equity versus fixed income weighting, but also where you are in fixed income.
Viktor: In terms of the asset allocation. As Brunella has mentioned, we had a slight overweight to equities, over the fixed income, in a view that the economies of the region are recovering, while on the other hand, we are seeing an inflationary shock in that environment typically would expect the equity market to outperform the fixed income market, though in the case of LATAM. This year, that hasn't been really that straightforward. I could say probably the fixed income market front run a bit the sell off equity markets then followed, we just have to be cognizant that in the fixed income side yields reached such high levels that from here, it's a bit as symmetric and we're already seeing correction in some of the biggest income markets which sold off heavily like Brazil or Peru. In terms of the fixed income part of the portfolio over the year, we have reduced our duration position. Basically, that's trying to protect ourselves against the rising rate environment. But now we are looking to gradually increase our exposure to longer dated bonds. That's on the assumption that the current large inflationary shock is about to peak and we also continue to run a large overweight exposure to Uruguay where we believe that the quality of institutions is very high, and the political risk is quite low, especially compared to the others.
Interviewer: Okay, great. Thank you. Um, what about the income side? Is best to talk about that perhaps Brunella? You could talk about the dividend side and whether dividends have come back across Latin America in the same way they have in many of the other markets.
Brunella: Yeah, so we have seen a recovery in dividend distributions from companies, I guess, even though companies had quite, I mean, in relative terms compared to historical levels, balance sheets were not as good as I mean, if we look at the last crisis that we had in the region, I think balance sheets at this point in time, we're in a more solid position across LATAM. And in particular, the holdings within our portfolio. I think companies were quite conservative by preferring to keep liquidity at hand at a time when uncertainty was high. So we saw during 2020, some companies reducing their payouts, and that has been coming back this year, if we look specifically at the data points for the trust, the earnings per share, so everything that we accumulated at the end of August 2021 was 2.66 compared to 2.21 Last year, so there has been quite a good recovery right of 20%. That's still below the pre COVID level. So in 2019, that was north of 4. But we need to bear in mind that currencies play here quite a big role in terms of the earnings per share in Pence in sterling terms, right. So, the 20% increase that we have seen to the end of August was even in a scenario where the local currency basket for LATAM as compared to the Sterling has been out of favour. So actually, the increase in local currency terms of the income generation and dividends has been more than 20%. So we're seeing that recovery coming through. And we believe that for the next year, we should continue to see dividends rising as companies have been commenting
Interviewer: And sticking with you Brunella anything you'd say about your positioning today about are there any themes running through the equity portfolio that you pick out?
Brunella: if we look at the mean from the country positioning, we do not take significant country bets. So, so, those views from a top down perspective for the macro, and the impact on markets would normally be an allocation in our bond and in our bond sleeve and leave that to the team where the expertise lies on doing that sort of allocations for us, what we do on the equity sleeve is the bottom up approach. And then being overweight those companies where we can find well the highest quality companies that decent valuations, so when we distill that into sectors, currently, our largest overweight positions are within consumer discretionary sector followed by industrials, real estate, IT - information technology. So, even in industrials, I would say that the tilt of the portfolio would be normally to industries which are more exposed to the domestic themes. So all those sectors which we are overweight, are probably going to be well positioned to capture recovery in domestic consumption stories across the region within Latin, and I guess we do on top of that, see some themes which I can lay out and in some buckets where we perhaps square positioning, so things like the digital future. So the growing digital integration and technology adoption across the region, creates a lot of opportunities for companies to expand their business models and also opportunities in areas like Ecommerce, FinTech and education. So companies like Mercado Libre, which are significant holding for us, or XP, which is a brokerage firm in Brazil, benefiting from the growing FinTech space or the rising adoption of investments and retail investors really becoming more aware and increasing their allocations to more sophisticated asset classes, and really the growth of capital markets in the region. So things the digital future theme is something that we believe it's one of the areas where we have positionings also infrastructure plays as we all know, there's a huge infrastructure deficit in the LATAM region. And big challenges which create opportunities for us to invest into quality companies and capture growth in investments in those areas. So things like OMA, which is an airport operator in Mexico, which benefits not only from air travel within Mexico, but also being exposed to the northern Mexico, all the manufacturing rise towards US and the competitiveness of Mexico in that region in terms of having a relatively lower cost of production is captured there by that exposure. We also have Rumo, which is a railway operator in Brazil, which manages the main line of grain exports from the main producing state Mato Grosso down to Central Sportivo. So the main corridor for sending over grains down to the port and then into China, where Brazil is the main provider of things like soy and has a growing increase in production in corn and exportation of corn elsewhere in in the globe. And things like Wilson Sons, for example, which operates ports, and also tugboats to capture the growth in in trade in the region. So that would be an other theme. And lastly, maybe otherwise it would be dragging off for ages is, is just financial services expansion. Along the lines of what I talked about XP, we also hold the position in B3, which is the stock exchange in Brazil is a vertically integrated Stock Exchange and has been benefiting from the financial deepening across the region and creating many opportunities for us. And we also see banks in the region also benefiting from that. So those are just a few themes, which we can classify. And lastly, we also have sustainable leaders as one of the filters and areas where we see opportunities, so multi environmental concerns in the region and globally, open up significant opportunities for us to invest in companies exposed to renewable, sustainable agriculture and transition technologies.
Interviewer: Now, as the dust settles, what would you say have been the key impacts of the virus for Latin America? Has it has it prompted political instability? Or has it seems strengthened trends such as Ecommerce? Viktor, that question to you?
Viktor: That's a very interesting question. I think we have already sufficient clarity to answer it, though it probably might change with time, but it's quite clear that COVID has exposed some of the long standing inequality issues in the region, most particularly in health care and education. But also questions were raised about the access to and profits from natural resources. The COVID was a big economic shock, to which many of the regional states reacted with generous state support in the form of cash handouts, employment protection schemes, I think that's the state's role, can hardly go back to pre COVID levels. But then we have the question kind of how far should the states hand reach and that will be decided, I think in the coming months and years, COVID could be a catalyst for positive change if it leads to more equality and better public services. But it could also lead to unsustainable fiscal trajectory, and even deter private investments in certain sectors. So just looking through the countries, what we have seen probably most happened in the Andeans in Colombia. Earlier in the year, we have seen that least three protests against the proposed tax reform, which obviously then failed, leading to downgrade by rating agencies, and to a softer version of the tax reform, which has now been approved. In Peru. We have seen the election of quite far left president, though it was quite interesting to see that the basically the establishment forced him to fire his first prime minister, and also other radical members of the government and appoint much less radical cabinet and also reaffirm the well respected central bank governor. In Chile, where we have the first rounds of the of the elections this weekend, we are most likely will end up with an interesting run off between the left and the right wing candidates in the second round. So it is a promise of higher spending versus a promise of lower taxes going against each other. And Brunella has already mentioned the Constitutional Convention, which is set to rewrite the Constitution. And probably such things as mining rights and rights to access to water will be addressed in that. Or we can also mention just going a bit further away from the Andeans, Mexico, where there are attempts to reverse the energy sector reform, which could be a big blow to the private sector investors who have invested heavily in this sector after it's opened up in 2013. So as I said, these are quite interesting and important questions which can set the trajectory for the years to come for the region. And I can say that nothing has been decided yet.
Interviewer: Viktor, I wonder if we could just wrap up by talking a little bit about the risks and opportunities across the region, as we look out over the next 12 months or so. Brunella mentioned the election there. So that's, that's obviously one but also the extent to which market prices reflect those risks today?
Brunella: Well, Latin America has become once again a high yield market where a lot of the political and inflation risk has been priced in going ahead, looking at the next couple of quarters, I think the global event recycle, and also the high commodities prices should be supportive for the region. I mean, the world needs to build back all those stockpiles which it used to have before COVID. And also, I think the theme of reshoring of manufacturing could also be quite interesting for Latin especially for Mexico, as we see how disruptive the long supply chains which reach across continents can be. So that is also something which should bode well for that region. In terms of valuation Brunella already touched upon it. But it is worth highlighting that both in equities and fixed income Latin America stands out in terms of valuation when we compare to other emerging market regions. So there is clearly interesting value there. And I think the most difficult issue in the medium term will be to recalibrate the role of the state and the private sector. And we're going to talk a lot about it in the coming months, not just in relation to elections, but more in general. So the region is now at the phase where it is redefining itself and the role of the state and we hope that it will have a positive outcome.
Interviewer: Great. Okay, thank you, Viktor, and Brunella, for those insights today and thank you to our listeners for tuning in. You can find out more about trust at www.latamincome.co.uk. And please do look out for future episodes.
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