How have Latin American equity markets performed?

Despite the MSCI EM Latin America index rising swiftly in the first four weeks of 2018, it has been a topsy-turvy ride ever since – and all of it downhill. 

This sort of market behaviour is nothing new. After taking a hammering in the 2008 financial crisis, Latin American equities had a strong rally between 2009 and 2011 – and then they slipped into a five-year period of severe underperformance.

Blighted by domestic issues and challenging global conditions during that period, equities in the region tumbled by 62 per cent.

Latin America, particularly Brazil, enjoys a young population and a rising middle class.Michael Wang

A glimmer of hope arrived in 2016 and 2017 when stock markets posted strong gains. But this couldn’t offset the losses of the previous five years and many long-term investors were left sitting on deep losses.

The challenges for equity investors in Latin America largely stem from fluctuating commodity prices, political shocks and economic mismanagement.

With so many economies linked to China’s growth prospects through commodity markets, prospective investors are surely hoping Beijing doesn’t face further restrictions on trade.

Nuts about Brazil

For the most part, investing in a Latin American equity fund means taking on significant exposure to Brazil.

While the region comprises more than two dozen countries and territories stretching from Mexico to the southern tip of Chile, funds generally focus on five markets: Brazil, Mexico, Chile, Colombia and Peru. Argentina only plays a small role in portfolios, while liquidity issues tend to preclude other markets.

Because of this, returns are heavily aligned with the fortunes of Brazil and Mexico. Tom Smith, co-head of emerging market equities at Neptune Investment Management, says Brazil has struggled in recent years as it grapples with economic challenges, and this has weighed on funds investing in the region.

“The investment climate in Brazil has been tough in recent years, with the recession – alongside double-digit inflation and unemployment – weighing on corporate earnings and the interventionist policies of the Dilma Rousseff government impacting business confidence and reducing visibility,” Mr Smith says. 

Disappointing returns

In many ways, volatility is a byword for Latin American equity markets. Large gains are frequently absorbed by even larger losses as markets gyrate between positive and negative sentiment.

“Latin America volatility is twice as high as emerging markets in general,” says Lena Tsymbaluk, investment analyst at Morningstar, who adds that much of this is being influenced by Argentina. The region is not necessarily cheap either, trading at higher average valuations than the broader MSCI Emerging Markets index.

When looking at performance data for Latin American equities over the past decade, it can be difficult to feel much excitement.

Table 1

In the 10 years to September 30, the index has returned just 6.8 per cent and is down 10.8 per cent over five years. Over shorter time periods things look better, with the index delivering a solid 46.9 per cent in the past three years.

Fund flows into the region have largely mirrored the fortunes of equity indices.

Data from Morningstar show net outflows of £13.2bn from Latin American equities for the 10 years to the end of 2017. The bulk of the outflows were between 2011 and 2016.

In terms of fund performance, Table 1 shows the performance of Investment Association-listed Latin American equity funds over the past 10 years. The Neptune Latin America fund is the top performing fund over 10 years to September 30 2018, returning 44.9 per cent compared with an average of 8.7 per cent for its peers. 

On the flip side, the Templeton Latin America fund is the worst performer over the past decade, falling by 12.1 per cent. It has suffered more over the short term than its peers, falling 13.3 per cent in the 12 months to September 30, compared with an average of -10.9 per cent for the funds in the table and -6.6 per cent for the top performing Neptune fund.

Drivers for the future

Michael Wang, a fund manager within the global emerging markets and Asia team at Polar Capital, says the drivers of equity performance in Latin America were previously tuned into global growth, but this has gradually shifted towards domestic demand.

“Latin America, particularly Brazil, enjoys a young population and a rising middle class,” Mr Wang says. “These demographic changes generate an internal driver of demand for many consumer products and services such as banking, internet connectivity and health care.”

Much of the region still needs large investments in infrastructure, Mr Wang says, and domestic demand is expected to be an increasing driver of returns in the future. 

Nevertheless, with the region’s fortunes so heavily influenced by commodity prices and US trade policy, investors should not expect smooth sailing by any stretch of the imagination.

Geordie Clarke is a freelance journalist