Portfolio manager’s Letter March 2011
It is no secret for investment manager that Latin American market have been great performers in recent years. Indeed, Latin American market outperformed important emerging market indexes during the last 10 and 15 years, as indicated in the table below (annualized returns ending December 31, 2010):
|MSCI Latin America
|MSCI Emerging Markets
For a value investor, this great 15-year outperformance automatically raises at least a yellow flag, as reversion-to-the mean is a phenomenon we pay attention to. Nevertheless, reversion-to-the-mean does not exist in the vacuum — i.e., irrespective of market fundamentals — and we have to consider Latin American market was cheap 15 years ago: the total market capitalization of all companies in Brazil, Mexico, Argentina, Chile, and Peru was less than $360 billion, i.e., some 10% more than the market cap of Apple today. The outperformance is justified and does not result in outrageous valuation levels.
So, on the macro level, Latin America was a great value trade for the last 15 years (actually, since the 1980s, which was Latin America’s lost decade — “history never repeats itself but it rhymes”, Mark Twain supposedly said). Going forward, it is our view that selective stock picking will have an increasingly important role for investment managers who want to allocate in Latin American market. In other words, we do not believe the region’s stock market indexes will perform as well in the next ten years as they did in the last ten.
Out of the Latin American market I have been following, Argentina is the cheapest and the one with most political risk (Venezuela was not considered). At the end of 2010, the market capitalization of all Brazilian companies (Brazil is largest player in the region) represented 74.0% of the country’s GDP. In Argentina, the comparable figure represented only 17.4%. This year when the Merval (Argentinian main stock index) returned more than 50%, while the Ibovespa (Brazilian main stock index) has practically stayed flat.
Currently, Brazil seems to be close to fair value, as does Peru. Mexico and Colombia seem a bit overpriced, and Chile is the most expensive market of the region (with a market cap to GDP of 176%).
Importantly, almost all these markets continue to benefit from the secular trends of strong GDP growth and enrichment of poor and middle classes, and all present favorable demographics and strong public debt to GDP ratios (which will probably translate into enhanced growth as Latin American populations increase their use of credit). Inflation seems to be under control throughout the region.
Of course, if you are a growth investor — not our case! — any of these markets is extremely attractive, as growth momentum is extrapolated into the future to justify any valuation. On the other hand, we share Warren Buffett’s opinion that growth is just one more component in the assessment of value and adhere to a Buffett less-advertised strategy: getting the benefit of growth without paying for it.
Traditionally, Latin American market have been treated as “commodity stories”, as the region is very resource rich and an important exporter of many commodities. Importantly, however, the internal-demand investment themes have developed significantly in recent years due to the macro factors indicated above — specially the enrichment of poor and middle classes, which results in strong internal demands and new consumer trends. If we find attractive valuations, these are the companies (internal-demand-related, not commodity-export-related) we will choose for allocation.
In mid-January I visited a series of public companies in Brazil, and when back I told portfolio manager Richard Losch “Well, I do have a favorite, but you may not like it …” Two words (textiles, and leverage) may make a rational investor run for the exit. However, against those two we would have a “discount to reproduction cost”. If the company were in the US, we would not make that investment. Since it is in Brazil, we are considering it …
More on Latin American market in the upcoming months.