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“Buena onda”: good vibrations in Latin America

February 2020

Viktor Szabó, Senior Investment Manager, Latin American Income Fund Limited

  • Stock market growth has outpaced economic growth in 2019, but we believe Latin American economies will revive in the second half of 2020
  • Low interest rates, an improving global economy and trade deals are creating a stronger backdrop for Latin American countries in spite of short term headwinds
  • The Aberdeen Latin American Income trust is positioned for growth

For Latin America, 2019 was a year in which the stock market defied the broader economy. Stock markets saw double-digit returns in spite of lacklustre growth as the region was beset by global weakness and domestic tensions. To thrive from here, economic growth will need to materialise, but we believe there are compelling reasons to suggest it will.

Latin America may not have seen the drama of the other emerging market behemoth, Asia, over the past 12 months, but it has given it a run for its money. While there has been no Coronavirus, or major trade dispute with the US, there has been major rioting in Chile, economic setbacks in Mexico under left-wing president Andrés Manuel López Obrador (AMLO) and an unexpected election result in Argentina. Equally, the region has had to contend with slowing global growth that has dented exports. It has not been immune from the impact of the Coronavirus, which has impact global manufacturing supply chains and, particularly important for Latin America, commodities prices.

However, in the longer-term we see brighter skies ahead. The US/China trade deal may not directly affect Latin America, but it does at least encourage the free-flow of trade around the globe. At the same time, Latin American has forged its own domestic deals. The US House and Senate have now signed the United States-Mexico-Canada Agreement (USMCA) into law. This replaces the the North-Atlantic Free Trade Agreement (NAFTA) and brings certainty to trading relationships between the three countries.

At the same time, the global economy is likely to provide a more benign backdrop for Latin American companies. The threat of a recession in the US appears to have been laid to rest, and a broader global cyclical upswing is possible once the impact of the Coronavirus has dissipated. We’re not expecting a significant shift in global economic fortunes, but the environment is generally better.

The US still holds sway over the Latin American region in general, particularly in Mexico. The Federal Reserve’s volte-face on interest rates last year has given Latin American central banks greater freedom to cut rates. In February, Brazil’s central bank reduced its benchmark interest rate by 25 basis points to a record-low 4.25%, the fifth straight cut. (https://www.reuters.com/article/brazil-economy-rates/brazil-cuts-benchmark-interest-rate-to-record-low-425-idUSAQN023X2D)

Not only has this enabled businesses and consumers to borrow at lower rates, it has reduced the yields on fixed income. Unlike many developed market government bonds, investors can still generate a ‘real’ (after inflation) income from Brazilian government bonds but it is much lower than it has been historically. Many investors have concluded, as we have, that it is time to rotate into the stock market, which has helped drive growth in share prices.

Lower interest rates have combined with strong jobs growth to support consumption, the largest market for the Aberdeen Latin American Income trust. To our mind, consumption growth remains the most exciting theme across the region as more people enter the middle classes. It is not only happening in Brazil, but also in Mexico, Chile, Peru and Columbia.

There are other encouraging signs emerging from the Brazilian economy. Brazil’s services sector in January grew at its fastest pace in 10 months in December. Manufacturing also showed real signs of strength. It suggests an economy that is diversifying away from its historic reliance on commodities with more opportunities emerging.

A notable success has been the expansion of venture capital funding. Brazilian startups received $2.7 billion in venture capital investments in 2019, 80% higher than in 2018 (https://labs.ebanx.com/en/news/technology/venture-capital-brazil-2019/). Over the longer-term, this broadens the opportunity set for us as investors and shows a thriving corporate sector. Brazil now has five of its own ‘unicorns’ (private companies with a market value of $1 billion or more).

For Mexico, the second largest stock market in the region, growth is not as assured. Business sentiment is weak; while many hoped that AMLO wouldn’t prove to be as left-wing as his early rhetoric suggested, his attempts at more business-friendly reform have largely been failures. The economy remains depressed as a result. However, we expect some improvement this year after a weak year last year.

What does this mean for our portfolio? We are positioned for growth, particularly in Brazil. The trust holds both bond and stock market exposure with the aim of paying investors a consistent yield. However, we have been moving away from our fixed income holdings in Brazil, believing there is more opportunity in the stock market, but retain some fixed income holdings in Mexico where yields are still high.

The trust performed well in 2019 and the discount narrowed a little. This was led by Brazilian markets where there was also a significant appreciation in the currency. Importantly, we largely avoided regional bear trap, Argentina. It represents a tiny part of the overall index and hold relatively few attractions for us. There was also, fortunately, limited contagion elsewhere.

We are looking forward to 2020, believing the Latin American economy is likely to be more vigorous once some short-term problems have been set aside. This remains a vibrant and rapidly-changing continent, presenting new opportunities for investors as it evolves.


Important information

Risk factors you should consider prior to investing:

  • The value of investments and the income from them can fall and investors may get back less than the amount invested.
  • Past performance is not a guide to future results.
  • Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
  • The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
  • The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
  • The Company may charge expenses to capital which may erode the capital value of the investment.
  • Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
  • Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
  • There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
  • As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
  • The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
  • Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
  • With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘subinvestment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
  • Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.

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