We are currently very keen on Latin America, especially Mexico. It is our largest overweight country position and we see value across hard, local currency and corporate debt.
The economy is benefiting from increasingly competitive wage costs compared with its export rivals, which is fuelling gains in its share of the US market at the expense of the likes of China and Canada. For example, the Mexican Ministry of Finance now estimates that Chinese wages are just 11 per cent lower than Mexican wages. Such a surge in competitiveness has led to the US capturing approximately 85 per cent of exports and therefore the Mexican economy is highly correlated to US industrial production and US growth.
Accordingly, growth forecasts for 2013 and 2014 remain robust at 3.5 per cent and 4 per cent respectively, with manufacturing and oil-related industry continuing to drive export growth.
Looking at things from a wider portfolio point of view, there are broader benefits. Investors can gain an extra layer of diversification as the correlation between emerging market debt and emerging market equity has fallen in the past 10 years. The reason for that is that the underlying fundamentals of emerging countries have improved significantly, and as a consequence, emerging market bonds trade like a traditional fixed income asset class.
Mexico is a prime example of this. If Mexican growth is weaker, because the Mexican government is in a very strong financial situation, the central bank has got the ability to cut interest rates. So weaker growth in Mexico will be good for the bond market and will lead to bond prices going up; in contrast, it might lead to some weakness in the equity market as companies’ profitability could be hit.
The recent weakness in emerging debt markets, for us, serves as an opportunity as we remain confident in the long-term story. We therefore use market dips to top up on our favoured positions, such as Mexico. However, while domestic ownership of emerging market debt is growing rapidly, foreign ownership of the bond markets remains relatively high which can lead to a degree of vulnerability in times of market stress.
Counterbalancing this though is not only the rising domestic ownership, but also the fact that the Mexican bond market is very liquid and therefore it is possible to trade in relatively large sizes. This trend runs contrary to popular belief, and extends across many constituent members of the emerging market bond universe. If you look at the market capitalisation both of domestic bonds and US dollar denominated bonds, the total size of the overall asset class is almost $8trn (£5.1trn).
Many perceptions of Mexico are outdated and have not been revised to take into account the huge progress that has been made in terms of economic and financial reform.
Long-term investors who are able to judge Mexico on its current merits and not its historic failings should be well rewarded.
Brett Diment is head of emerging market and sovereign debt at Aberdeen
