An update from managers Viktor Szabó and Mubashira Bukhari Khwaja
In this podcast, managers Viktor Szabó and Mubashira Bukhari Khwaja discuss the impact Covid-19 has had on the Latin American region. They discuss the positioning of the Trust heading into the crisis, how they have reacted and what they are doing to prepare for the future.
Recorded on Friday 29th May 2020
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Interviewer: Welcome to the latest in our Aberdeen Standard Investment Trust podcast series where we catch up with our investment trust managers to look at how the COVID-19 outbreak is impacting their portfolio . Today we welcome Mubashira Bukhari Khwaja and Viktor Szabo, Managers on the Aberdeen Latin American Income Fund. Welcome to you both. What has been Latin America's experience of the crisis? Viktor, could we start with you on that?
Viktor: Sure. Latin America reported its first coronavirus case in late February and the virus has spread across the entire region since. Countries responded in different ways, but some form of mobility restriction has been introduced on national or regional levels everywhere. Countries with stricter lockdown measures manage to flattened their infection curves, but those where presidents opposed lockdowns, like Brazil and Mexico, are still seeing high infection rates and are now in the epicenter of the pandemic.
Mubi: Looking at stock market performance, Latin American markets have been hit the hardest due to the risk-off sentiment because of the commodity exposure. If we compare current year-to-date performance, the MSCI Latin American index is down almost 39%, which is significantly more than the MSCI emerging markets index, which is down around 17%. So there is some sharp underperformance that we've seen for the region until now despite the rally -- the recovery that took place in April and May. If you look at within the region and at individual markets then Brazil was a clear laggard. This was primarily because starting the year, going into the year expectation was that there would be a domestic recovery, and now that recovery is derailed because of the virus.
Interviewer: Okay, and how have policymakers responded? Have you seen the same kind of stimulus packages and monetary policy moves that you've seen in developed markets?
Viktor: Yes, we saw really bold policy responses. Central banks across the region cuts their policy rates aggressively and provided liquidity support to their banking sectors. We saw intervention on the foreign exchange market, plus several countries contemplated allowing central banks to support local bond markets with direct government securities purchases. New loan and refinancing facilities were introduced to help the corporate sector with their financing needs. Meanwhile, the US Federal Reserve broadened its swap lines to include Brazil and Mexico hence providing additional access to US dollar liquidity for these countries. The fiscal response was also overwhelming, with special focus on protecting the most vulnerable households and companies and safeguarding jobs. Amongst other measures, this includes direct cash handouts, tax deferrals, acceleration of tax refunds, broader unemployment coverage and government loan guarantees. Chile’s stimulus package is equivalent to 4.7% of GDP, whilst Peru’s total measures could reach up to 17% of GDP. Brazil increased its primary budget deficit by 4.4% of GDP, while Colombia also announced an increase in social welfare programs and credit lines. The only notable exception is Mexico, where the administration was relatively slow to react to this pandemic outbreak and still wants to maintain its original tight fiscal funding objectives with only relaxation allowed in healthcare related spending so far.
Interviewer: Ok, Mubi, I know it's very early days, but what are your assumptions about the economic impact? Is it very different for different sectors and different geographies, for example?
Mubi: Yes, so the economic impact for the region would depend on which market you're looking at, and that is determined by the time period of the lockdown . But if you look at Latin America and consider factors such as ICU beds per 100,000 inhabitants, or popular support for isolation then Chile stands out in the best position. That would be followed by Peru, Argentina and Columbia. The larger markets like Mexico and Brazil are clearly lagging and the expectation is that they may take longer to normalise. But this does not mean that we may not see a second half recovery, that is possible, but it is quite clear that GDP contraction is unavoidable at country and regional level. So far estimates are -- and they are changing every day, but so far the estimate is that for the region as a whole GDP contraction would be around 7% and Brazil and Mexico would be the hardest hit. If you look at economic impact by sector, then yes, it would be very different by sector. COVID-19 will have a lasting impact on consumer behaviour for sure. There will be some winners like e-commerce companies that will benefit from growing adoption and also there will be some losers. This could potentially be real estate companies and airlines that can face a slower recovery.
Interviewer: Okay, and maybe another question for you if I may - how was the trust position going into the crisis, and how has it performed through this volatility?
Mubi: So starting the year we were positioned for domestic recoveries in the regions, particularly in Brazil, which hasn't come through. It’s a different world now than it was at the start of the year. There has been an impact from a currency and stock selection perspective as a result of that. So the benefit we saw from an underweight to financials going into this crisis, particularly banks and insurance companies, and the underweight to energy going into this crisis has helped us offset to a large extent the overweight to consumer discretionary names.
Interviewer: Okay and have you made any changes to the portfolio as the crisis have unfurled and the pictures become a bit clearer?
Mubi: Certainly, so given macro expectations are now very different we have made changes to the portfolio to appropriately reflect our current macro views and also to take advantage of changes that are apparent in different industries. So we have added to sectors that would benefit from lifestyle changes as a result of COVID-19, and in here particularly e-commerce names such as Mercado Libre, as well as recovery plays such as the Brazilian Stock Exchange. We have added to these positions. We've also selectively topped up financials, but in particular banks which are well capitalised and high quality and in a better position to absorb the losses due to this crisis, and they're still offering value.
Interviewer: Okay, and Viktor, you handle the fixed income section of the portfolio. Have you made any changes there?
Viktor: Yes, on the fixed income side we have reduced our exposure to Brazilian rates and the currency as within, this country mismanages the pandemic. On the other side, we have increased allocation to Colombia, and also added duration exposure in Peru.
Interviewer: Okay, and Mubi to what extent do you think equity market prices fully reflect the risks of Latin America? Have markets overshot or is it sort of fair value now?
Mubi: Okay, so if you look at the region as a whole in terms of price to book ratio for instance, then currently after the recovery in April and May, the price to book for the region is about 1.6 times, which is similar to the average since 2006 for instance. But, this is misleading to an extent, because at the corporate level we haven't seen a full recovery, especially in companies that we would like to invest in, so high quality names. We haven't seen a recovery there. Momentum stocks have done better, and we think that there is still an excellent opportunity for bottom-up stock pickers like ourselves to pick up high quality companies at valuations that are cheaper than they were before the crisis.
Interviewer: Okay, and what has happened on the income side? I mean in the UK we've seen a lot of distress among dividends and about half of companies have cut their dividends. What's the picture there? Are you seeing companies able to sustain their payouts?
Mubi: Certainly we have seen companies even with a strong balance sheet to be in a cash conservation mode, and so there have been dividend cuts in many sectors, in particular banks. Across the board we've seen that they have been reducing their dividend payout. And this is certainly not something that we are opposed to as long as we feel that there is a good reason for it and we understand that given the level of uncertainty it’s quite natural for these companies to preserve their cash.
Interviewer: What about the fixed income side Viktor?
Viktor: What we have seen is a knee jerk reaction to the global risk sell off in March and it was a sharp depreciation of the currencies then the rise in yield, which was basically consistent with the large portfolio capital outflows we have seen across all emerging markets. However, LATAM central banks started to cut rates and outflows subsided, we have seen stabilisation and then the recovery in currencies, and local rates markets also strengthened. While the long end yields in most countries are already below their pre-covid levels, the short end of the curves rallied so much on the back of Central Bank rate cuts that yield curves are now quite steep and that’s why duration looks quite attractive.
Interviewer: Okay, back to you, Mubi if I can. I recognise that it's very early days, but are you getting any feedback from the companies you're talking to that gives you some kind of clues as to what the future might look like?
Mubi: Yes, so it’s undoubtedly a very tough time for companies across sectors. There's a lot of uncertainty, we've seen many of our companies withdraw guidance as well for the full year. But the message we are getting from most of our holdings is that it could be a chance for them to strengthen their market positioning. This could be organic through the weakness of their peers or through M&A. So while there is a lot of uncertainty, there are also opportunities which are emerging.
Interviewer: Okay, great. So to what extent do you believe companies can kind of bounce back?
Mubi: So the bulk of our portfolio is positioned to benefit from domestic demand. So we would expect a significant bounce back for those companies as lockdowns would ease across the region. But having said that, certain businesses which, in particular for retailers, for instance, which had the competitive moat previously based on ownership of physical stores, that may see that moat being weakened by emerging trends, such as faster penetration of e-commerce going forward. We don't expect such businesses to go back to previous ways of doing business, generating the same kind of operational results. And as a result, we have made changes for our portfolio in recognition of these risks, and we're comfortable with our position now.
Interviewer: Okay, great. And just finally to you Viktor, any closing observations about the environment that we find ourselves in today?
Viktor: Well, this is an unprecedented shock with unprecedented policy support as well. So now countries will start to gradually reopen, and hopefully in around two months’ time economic activity will normalise and growth will recover. Even if in some sectors like tourism and hospitality, recovery will take a very long time. So as investors, we have to keep in mind that every downturn also creates opportunities, and the Latin American region now offers plenty of those.
Interviewer: Great, okay, thank you Viktor and Mubi as well for those insights today, and thanks to our listeners for tuning in. You can find out more about the Trust at www.latamincome.co.uk and please do look out for future episodes.
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