Top funds 2003: Latin America's investors rode the Lula wave. Now they watch and wait

Latin Trade, Jan, 2004 by Greg Brown

No one owns market wisdom, but the best investment funds in Latin America agree at least on what to watch: a recovering Brazil and the United States, in that order.

Net inflows of private financing by way of equities--that's mostly investors looking to directly buy shares of Latin American companies--should rise to US$32.2 billion in 2004, a return to 2002 figures after bottoming out during 2003 (although just half of 2001's dotcom-inflated stock markets, when inflows hit nearly $60 billion), according to the International Institute of Finance (IIF). Nonbank private creditor inflows--mostly in the form of corporate bonds--will hit $13 billion in the year ahead, up from $8 billion in 2003 and far outpacing 2002's $4 billion net outflow of private credit.

That incoming cash should help as economies across the region recover from the global slowdown, now well into its second year. The IIF, a global association of financial institutions, forecasts Latin American gross domestic product (GDP) growth at 3.3%, ranging from 2.7% to 4.5% for 2004. Fully one-third of equities money will go to the region's largest economy, Brazil, the group reports. Much of it will end up in the hands of banking and utilities companies eager to pick up market share as the Brazilian economy rebounds, according to the IIF

In a certain sense, betting big on Brazil was the inverse strategy of the best fund in that country during 2003. Call it the "Lula factor" if you will. The campaign of left-wing candidate and former union leader Luiz Inacio Lula da Silva, now president of Brazil, created a fog of doubt among most investors. Some fund managers figured the negative talk would hold down share prices for a while, so they loaded up. Once the election was over, equities rebounded.

Roseli Machado, manager for Fator Administradora de Recursos, took the Lula-hysteria bet. By the time the election had shaken out, she had piled up a 128% nine-month return on the year, in part she says by steering clear of industries beset by structural problems and instead pouring money into heavy industry blue-chips held down by low expectations of Lula.

"We avoided regulated sectors, such as telecom and electricity, because inflation was high and we were afraid that, at that moment, the government could begin regulating rates," says Machado. "Those sectors were more influenced by politics, so we stayed out."

Feng Ding, manager of Barclays Global Investors iShares Brazil, says her index fund--which tracks the Morgan Stanley Capital International (MSCI) index for Brazil--saw Investors flee the country to avoid taking a bath on Lula's election, a fear that soon became a self-fulfilling prophecy: So many reduced their Brazil holdings that, as a result, shares fell.

Once it was clear that Lula would follow the economic game plan that kept Brazil rolling through the 1990s, investors eagerly bought back in. Mechado sees interest in Brazilian stocks returning, even a big bump-up early in the year, but November presidential elections in the United States could put an end to the party. Since iShares tries to match the entire market, Ding doesn't recommend individual stocks. Nevertheless, she says, watching equities is high on her list in the months ahead. "Going forward we need to see some real corporate profits growth, "says Ding, "We need fiscal policy to be seen in corporate growth."

Argentine growth is a given, if only because the economic disaster of late 2001--and a virtual burning at the stake of Argentina's financial system--has finally pushed the country into a competitive position. Exports are suddenly hot, and resurging growth after so many black months means the construction sector should provide some economic juice, fund experts say.

Finally, too, this likely will be the year Argentina and the world's creditors come eye-to-eye on fixing its broken-down banks. "We are still optimistic about the financial system in 2004," says Gabriel Ruiz, manager for Santander Investments Argentina, the asset management company of Banco Rio.

Probably the least questionable economies in Latin America are those of Chile and Mexico. A newly inked trade deal for Chile with the United States, on top of a pact with Europe, means exports will begin to get even more traction than before. A side effect of more trade, however, is that incoming dollars could sidetrack companies that export because their foreign earnings will be deflated by a declining local currency. Elias Egnem, equities manager for Celfin Acciones Chilenas, says he's looking instead to reforms in Argentina's utilities sector to help Chilean electricity stocks, a heavy component of the Chilean stock market, as well as increased sales for Chilean companies with holdings abroad, like bottlers.

Mexico's performance, meanwhile, is geared almost directly to a U.S. recovery, with all the doubt that comes in the second half as U.S. President George W. Bush tries to hold on to the White House. The top Mexican fund, Accival, made its money by balancing a prudent position in bonds with blue-chip equities such as Telefonos de Mexico and Bancomer--much like any run-of the-mill U.S. pension fund. So predictable, now, is the U.S-Mexico relationship that the IIF's investment forecast glosses over Mexico almost completely. Ah, to be predictable in an unpredictable world.