Latin America has been one of the regions that has been hit hard by the Covid-19 pandemic. This is partly due to the handling of the virus in certain countries, but also to the extent of informal labour in this part of the world that have made social distancing and lockdown impractical.

Some believe Latin America to be in a good position, however, and it can benefit from the global economic recovery.

Aberdeen Standard Investments Latin American investment manager Eduardo Figueiredo believes Covid-19 has been a catalyst for change in the region, as many firms used the pandemic as a trigger for change with efficiency and digitalization initiatives.

As a market particularly reliant on commodities, the region’s economies should also benefit from the reopening of global trade. Figueiredo also sees a widening investment universe in sectors such as digitalisation, infrastructure, renewables and healthcare.

He also observes that corporate earnings in Latin America are seeing a steady recovery.

The region can also count with a young and growing populations, underpenetrated sectors, infrastructure deficit and vast natural resources. Figueiredo sees this as “massive opportunities” for investment beyond the pandemic.

He says: “The macro environment for Latin America appears largely supportive, though risks remain. Covid-19 remains a key challenge, with caseloads still high, spread of new variants and sluggish pace of vaccinations.

“However, trends suggest that we are unlikely to see the re-introduction of strict restrictions. Inflation is another concern, with central banks in Brazil and Mexico already compelled to tighten policy, albeit rates are broadly still at reasonable levels.

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“That said, rising consumer prices are also reflective of the upturn in growth across the region. For instance, Brazil is benefiting from quickening economic activity, a healthy current account and a favourable outlook for commodities. Mexico is enjoying robust support from the rebound in manufacturing activity in the US.”

In addition to this, Latin America has seen a successful vaccine roll-out compared to other emerging markets. For example, Chile and Uruguay have fully inoculated more than 70% of their population.

Structure of the market

BlackRock Latin American Investment Trust portfolio manager Ed Kuczma defines the space through what he calls the four C’s: commodities, consumption, currency, and credit.

He says: “It is home to abundance of natural resources and they also come at a very low cost, whether it’s digging out iron ore or producing copper.

“The region has some of the largest scale mining operations, the largest deposits, longest life of mines, and largest reserves. They also come at low cost of production.

“We see commodities as an important driver of growth in the region.”

With the incoming ‘green revolution’ and the potential structural shift to electric vehicles (which require industrial metals such a lithium and copper), Kuczma thinks Latin America is well placed to benefit from a rising demand and therefore of the rising price of commodities.

Consumption is being boosted by an emerging middle class in Latin America.

Kuczma says that there is a lot of liquidity in the region at the moment as a result of fiscal stimulus and pension withdrawals in some countries where governments have allowed it on the back of the recent pandemic.

As a result, he sees consumption as an attractive way to play in the region. The underpenetrated nature of per capita consumption gives room for leapfrogging, for example in the e-commerce sector.

He adds: “E-commerce, as a percentage of total retail sales, is about 8% in the Latin America versus 30% in developed markets.

“We see a lot of growth in this digital transformation of the consumer, taking the best practices from developed countries and tropicalising them for South America and the consumer base.”

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BlackRock has noticed a strong demand for loans that are benefiting the banking sectors within Latin America.

“Loans as a percentage of GDP is extremely underpenetrated in countries like Mexico.

“We see a greater emphasis on financial inclusion and improving the credit penetration.

“The higher interest rates also support the net interest incomes for the banks.

Currencies in Latin America have been particularly cheap over the past five years, especially after a period of depreciation versus hard currencies such as the US dollar or the pound sterling.

However, Kuczma believes that Latin American currencies should appreciate in the coming times.

He says: “Given the high demand and high commodity prices, commodity-exporting countries are going to move from current account deficits to current account surpluses.

“We have also seen in Latin America across pretty much all the countries a strong shift towards monetary policy hiking.

“Historically, whenever commodity prices are this high, currencies appreciate. We have not seen that connection yet, but I think it is because of the political risks. Now that some of the elections in the region are over, I think we will see a return to some of these historical correlations.”

Political risks

Latin America is a region that has historically been characterised by a relative political instability, and this is still the case in some countries.

Barings head of global sovereign debt and currencies Ricardo Adrogué said: “One big shift has been Venezuela. In spite of economic deteriorations, the country suddenly went into a dictatorship.

“It has caused massive dislocations of people, with people leaving the country in big numbers.”

Adrogué added that Argentina could follow a similar path, as a fraction of the population is favourable to Cuba and Venezuela could vote their candidate into power.

Chile is reforming its constitution, but Adrogué says it seems to be done on a “relatively sound footing” with “unlikely result in a major rupture”.

There has also been a relative confusion following the presidential elections in Peru.

“Peru has just elected a president who is calling for significant changes in the constitution, and potential changes to the mining companies,” says Adrogué.

As a result, Adrogué considers that Chile, Mexico and Uruguay are the countries where investments are the safest, thanks to their political stability.

He also includes Colombia, Brazil and Peru as countries as relatively safe places for investments.

However, Chile will elect a new president in November and Brazil in October next year.

Liontrust Latin America fund manager Thomas Smith said: “Pro-business, centrist candidates should see a continued improvement in the business environment and further progress with reforms.

“However, if either country moves back to the left, as Argentina and Peru have recently done, then we are likely to see lower growth and higher levels of debt which would be a headwind for equity market returns.”

Regional heavyweights

Brazil and Mexico are the two largest markets in Latin America and also the places where the best investment opportunities are to be found.

Due to its geographical location, Mexico’s economy is deeply intertwined with the US economy.

Liontrust’s Smith says: “Mexico is benefitting from the economic recovery in the US and the pick-up in global trade, being the country with the most free-trade agreements globally.

“The fiscal prudence of Mexican president Andrés Manuel López Obrador is unlikely to change, which could weigh on more domestic drivers of growth.”

Mexico is also strengthening its position as a manufacturing hub as China’s population is beginning to shrink.

In addition to this, Barings’s Adrogué thinks that Mexico should benefit from the USA’s efforts to decouple from China.

In contrast, Brazil is less reliant on the USA. In fact, Adrogué believes that it could be a self-sufficient country.

As such, Brazil’s economic structure differs from its Mexican counterpart.

Liontrust’s Smith says: “For Brazil the key drivers are the ongoing economic recovery, progress on structural reforms, and fiscal consolidation which will provide renewed confidence in the sustainability of government debt and help to anchor long term yields even as short-term interest rates move higher.

“This will accelerate the flows from fixed income into equities, as well as shoring up fiscal accounts, structural reforms should lead to a smaller state and stimulate investment from the private sector which will push up potential economic growth.

“Low-cost commodity exporters are benefitting from the global recovery and the handover from monetary to fiscal stimulus led by infrastructure investments and green initiatives.

“Iron ore miner Vale is generating a huge amount of free cash flow and with no debt and limited expansion plans a lot of this will be returned to shareholders. Its dividend yield could reach 15-20%.”

Yet, Fidelity International portfolio manager Chris Tennant warns that Brazil has a large fiscal deficit and debt problem, which worsened because of the pandemic.

He says: “Investors will be looking for tax reforms and an overhaul of the tax system, as well as cutbacks in social spending.

“However, as socialist candidate Lula runs again for election, it casts doubts over the feasibility of the latter. Overall, we are neutral on our Brazil’s country exposure, given this macro uncertainty.”

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How does Latin America compare to other emerging markets?

Latin America relies predominantly on commodity exports and are as such natural resource owners and exporters.

In comparison, Asia’s large economies are natural resource importers.

Invesco Asian and global emerging market equities fund manager Charles Bond says: “China is the world’s largest importer of oil. Taiwan and South Korea are both large importers of raw materials and commodities.

“Asia and Latin America have different drivers. The key difference is the economic stability as a result of that.

“Countries like China, Taiwan and South Korea have developed large manufacturing export bases. Therefore, their ability to control their economic growth is much greater.

“In comparison, countries relying on commodities tend to struggle to reallocate their human capital when their particular commodity is out of favour. They tend to be more fragile economies as a result.”

BlackRock’s Kuczma remembers that Latin America made up to 20 to 25% of the US MSCI emerging market index when he started investing in emerging markets in 2004. It has shrunk to roughly 8% of the index.

“This reduction in Latin America’s representation in the index reflects our views that the region is under-owned, under-valued and overlooked by investors.”

However, Latin America can boast to have seen the highest 2021 earnings growth outlook in emerging markets with supportive valuations.

American Century Investments senior portfolio manager of emerging markets equity Patricia Ribeiro believes that emerging markets will have more room to recover because the post-pandemic global economic recovery is not completely reflected in these markets.

She adds: “While many information technology and communication services stocks were volatile in the first half, it’s important to emphasise that we continue to see an upward momentum in existing trends, such as digitization, cloud-based computing, and e-commerce.

“Companies well-positioned to deliver on these secular trends remain attractive and should continue to support emerging markets.

“While these trends have normalized somewhat after the extraordinary growth during the pandemic, year-to-date 2021 data remain above pre-pandemic levels.

“We are also seeing an improvement in cyclicals and sectors with a greater sensitivity to stronger GDP growth. Financials and conventional cyclical sectors positioned to benefit from the reopening of the global economy (such as materials) still have room to recover.”

ESG in Latin America

Liontrust’s Smith says that emerging market firms tend to have lower ESG rankings than global peers.

He also says that Latin America on aggregate is slightly behind other emerging markets as a whole.

Chile is the exception to the rule as it is ranked highly among emerging markets.

In addition to this, Smith sees a positive momentum across the region.

He says: “In Brazil more than 85% of power is generated from renewable resources, one of the highest levels in the world.

“The B3 (stock exchange) has the Novo Mercado (New Market) listing segment which includes only the companies with the best governance practices and there are currently 155 companies listed in this segment.

“In Mexico, the adoption of ESG policies has been driven by companies with large exposure in ESG advanced markets such as the US and Europe. Walmart and Fibra Prologis, subsidiaries of American companies, have started to adopt some of the parent’s best practices in Mexico.

“Chile continues to strive to improve standards of sustainability and policies regarding ESG, with contributions from both the public and private sector. Chile was the first country in the Americas to issue sovereign green bonds to channel investment towards green assets.”

Chile and Colombia also ranked among the top 50 on the Environmental Performance index from Yale.

But there is also room for improvement in the region on social issues.

“On the social front, the region has a long way to go to reduce inequality, but laws and regulations are in place to protect workers’ rights, to provide access to healthcare and education to the whole population,” says Victory Hill Capital Group co-chief investment officer Eduardo Monteiro.