Clawing back: after a dismal 2002 fund managers foresee a modest recovery

Latin Trade, Jan-Feb, 2003 by Mike Zellner

The coming year promises to be much better for fund managers if only because last year was such a rout. The Argentine default, Brazilian electoral jitters and exchange-rate turmoil plus a sluggish world economy waylaid even the best of investors. Argentina's Consultatio Balance Latin American Fund battled through default, devaluation and deposit withdrawal restrictions to break even for the year ending on Sept. 30, 2002.

"We defended our capital against everything," says Consultatia fund manager Diego Trucco.

When the dust settled, 2002 private capital flows into Latin America were estimated to have fallen by a third to less than US$30 billion--about the same level as 10 years ago--according to the Institute of International Finance. The biggest change has been declining direct foreign investment flows; portfolio investment has been slow or declining since 1999. The IIF predicts that flows will recover to almost $40 billion--thanks to increasing private credit--in 2003 as modest economic growth resumes in the region.

Worldwide, the IIF expects net private flows to emerging markets in 2003 to be $123 billion, the lowest level since 1992 and far lower than the $187 billion annual average of the past 10 years. The largest single area of net private capital flows remains foreign direct investment, although the IIF forecast the 2002 total for such investments to be $20 billion below last year's $113 billion.

Assuming global economic recovery, net private flows should rise to $151 billion in 2003, the IIF says, but it notes that this estimate reflects more a decrease in private capital outflows from crisis-struck countries than an improvement in public finances and economic indicators.

Guillermo Mazzoni, research manager for Thomson Financial in Brazil, says that Chile and Mexico should move forward, but Brazil will remain a big question mark." What Lula does will set the tone for the Southern Cone and the Andean region," he says. "If he can win the confidence of investors, we may enter a virtuous circle with everybody talking about the 'Lula phenomenon."'

Brazilian President Luiz Inacio Lula da Silva will have an uphill battle in Brazil. The past year was not kind to Brazilian funds as net withdrawals hit Sig billion. A 40% decline in the real exchange rate and presidential elections contributed to the decline, but local authorities exacerbated the drop with poorly timed regulations to increase transparency. A government measure required funds to recognize changes in the market values of holdings right away instead of at the end of each period. "The day-to-day ups and downs was too much for investors," says Mazzoni. "It scared them." The regulation took effect in June and was watered down in August.

If Brazil scared investors, Argentina gave them heart attacks. The country's economy is expected to contract as much as 18% in 2002, with imports falling by half, according to the IIF. "No one foresaw what happened in Argentina," says Trucco, who emphasizes that the trouble was far worse than anybody expected. The fund manager was among the few that prevailed because his fund had the option to invest abroad. The rest were trapped in the market with nowhere to go.

Mexican fund managers had nowhere to go, but not because of any deposit withdrawal restrictions. Funds are required to invest locally, so fund administrators like Hector Madero, of Actinver, have taken to seeking small companies to get additional returns. His investments in stocks like homebuilder Geo, specialty steelmaker CH and franchise holder Alsea, have separated Actinver's Acticrece fund from the pack.

Outsiders are also increasingly turning to the Mexican securities market as a way to achieve better performance from a U.S. economic recovery. The thinking is that Mexico will grow in tandem with the United States but faster. In fact, some investors speculate that Mexico now resembles the poorest state in the United States.

Chile is taking on the characteristics of a developed country too, although not a poor one. Mazzoni says a lot of the country's funds started diversifying risk from Chilean instruments to international fixed-income investments after September 200t But, when turbulence appeared, investors came home. "Chilean debt instruments are very low risk," says Mazzoni. "It's as if you were putting your money into the debt of General Motors."

Rodrigo Espildora, senior portfolio manager of BCI Frontera, questions whether U.S. corporate debt is such a good bet right now. The returns are not there, he says. For the time being, he is remaining in Chile until global markets settle down and present a clearer direction. He has spent a considerable amount of time with most of his portfolio at home in dollar-denominated debt in recent months, but he says he will keep his eyes peeled for opportunities outside. "We look at solvency, not sectors, so we will invest anywhere if the conditions are right," says Espildora.

The market direction in Asia, Europe and the United States remains unclear and Latin America shows no strong signs either way, says Rodrigo Xavier, co-head of the asset management division of Banco Pactual in Rio de Janeiro. He says that investors should stay on the fence. "The market has been overshooting on both sides," he says. "The best place to be is in the middle."