For many investors, the notion of emerging markets is closely intertwined with the Asian Tigers, perhaps because of their close proximity to the Chinese economy. Another major emerging economy bloc, found in South America, barely makes a blip on the radar of global investors. That’s likely because of the prolonged deep slump in Brazil, Latin America’s largest economy and the leading trading partner of many South American nations.
But those emerging South American economies not named Brazil deserve a look because, by many measures, they are sowing the seeds of a rising consumer class; are now being overseen by smart, investor-friendly government policies; and have the ingredients in place for sustained long-term growth.
Specifically, we’re talking about Argentina, Chile, Colombia and Peru.
Bienvenido Señor Macri
It’s easy to forget that Argentina at the dawn of the 20th century was the world’s seventh-largest economy, with abundant natural resources that made it an export powerhouse.
But for much of that century the country was dogged by polarized politics, by government policies that penalized wealth and by staggering levels of corruption. During the two-term presidency of Christina Kirchner (2007-2015), Argentina wasn’t an investor-friendly place.
But the narrative changed last November when Mauricio Macri became president and took the nation in an entirely new economic direction. Macri “implemented a lot of changes very quickly, removing tariffs, letting the currency fall, tackling corruption and bringing the nation back to global bond markets,” says Jay Jacobs, the research director at Global X Funds.
Yet analysts caution that those efforts will take time to bear fruit. Indeed, the Argentinian economy is expected to shrink 1.5% this year, says the World Bank, before turning around and growing an expected 3% next year.
To really unshackle the economy, Argentina will need to tackle its current inflation rates of 40%—mainly by retaining very high interest rates. That was the playbook used in the U.S. with great success by the Federal Reserve’s Paul Volcker 35 years ago.
Will Landers, the head of global emerging markets for BlackRock’s fundamental active equity team and the portfolio manager for the BlackRock Latin America Fund (MDLTX), says the high interest rates will be anti-growth in the beginning, but if inflation comes under control in the next 18 months, the Argentinian economy’s growth rate could then begin to accelerate.
“Argentina has huge potential,” he says.
Investors are showing their approval for President Macri’s tough medicine—witness the 30% jump this year [as of late-September] in the Global X MSCI Argentina ETF (ARGT). That increase makes up for a string of losing years, leaving this fund right back where it stood five years ago.
Mason Wev, a portfolio manager at Clark Capital, has been overweight in Argentina for much of 2016 and sees continuing gains for the ARGT ETF. “The valuations of the holdings in this fund remain quite reasonable,” he says.
The fund, which carries a 0.75% expense ratio, has more than 20% of its assets in both basic materials and consumer cyclicals. Steel pipe maker Tenaris is the top holding, while e-commerce firm MercadoLibre is the second-largest position.
The Other Side Of The Andes
Chile has emerged as something of a poster child for clean government and pro-business policies in recent decades. That enabled the nation to surpass Argentina as the country with the highest GDP per capita in South America in 2006. By 2013, the World Bank deemed Chile a “high-income economy.”
To be sure, a deep slump in copper prices has taken the sheen off Chile and its stock market. The economy is expected to grow just 1.5% this year, according to the Organisation for Economic Co-operation and Development, though the 2017 outlook calls for an upturn to 2.5% growth.
The slump in commodity prices has provided a very helpful test for nations in the Andean region (geopolitically speaking, neither Argentina nor Chile is considered an Andean state though they share the Andes Mountains along their long mutual border). In recent years, nations such as Chile, Colombia and Peru “have handled the commodity slump much better than they did 10 or 20 years ago,” says Fran Rodilosso, portfolio manager for fixed-income ETFs at Van Eck Global. He adds that they now carry much lower levels of external debt than in the past, and “they no longer raise fears around solvency.”
The iShares MSCI Chile Capped ETF (ECH), which sports a 0.62% expense ratio, has more than 25% of its assets in the Chilean utilities sector; its allocations to consumer cyclicals, financial services and industrials are 16% each. Despite Chile’s perceived dependence on copper, this fund has less than 13% of its assets in basic materials.
The fund’s 17% as of late September return follows three straight losing years before 2016, so a significant upside is very feasible.
Colombia’s Peace Dividend
Despite a civil war that spanned five decades, Colombia has managed to build a thriving consumer middle class during the past decade. Its economy is now the third-largest in Latin America, behind Brazil’s and Mexico’s. A recently announced armistice between the government and FARC rebels could allow the nation to redirect its spending away from security and toward more productive sectors. And as part of the peace agreement’s land reforms, millions more Colombians may have the chance to build wealth and join the economic mainstream. (A national referendum on the treaty was set to occur in early October after this story went to print.)
A heavy reliance on oil exports led the Global X MSCI Colombia ETF (GXG) to fall a steep 41% last year, even after the fund racked up double-digit losses in the two prior years. Relatively stable oil prices and the potential benefits of a peace dividend help explain this year’s 28% gain. Still, the multiyear underperformance in recent years means that the average holding in this fund trades for just 1.05 times book value. That compares with a 1.37 times price/book ratio for all of the MSCI ACWI Ex USA Index.
The Colombia ETF, which carries a 0.61% expense ratio, has roughly one-third of its assets in financial services while the utilities and basic materials sectors each have allocations of 15% to 20%. The fund has been trading since 2009, and the asset base has steadily grown to nearly $100 million.
The iShares MSCI Colombia Capped fund (ICOL) is another option for investors. It has a 0.61% expense ratio, and has an even higher 42% weighting in financial services, which may explain its more modest 24% gain thus far this year. The fund has only been trading since the middle of 2013, and has a smaller $17 million asset base.
Peru’s Centrist Path
As in Argentina, a new government in Peru is leading to expectations of investor-friendly government policies and a badly needed crackdown on corruption. Pedro Pablo Kuczynski worked at the World Bank and the International Monetary Fund before entering Peruvian politics, and he became president of Peru in July 2016.
Even before he took office, Peru has seen a lot of private investment in areas that should expand the middle class, says BlackRock’s Landers. Kuczynski aims to boost growth in poverty-stricken areas as well, with plans such as extending potable water and better roads into every Peruvian village.
A decade ago, Peru was beset by violence, drug trafficking and extreme poverty levels. Yet over the past decade, according to the IMF, it has been one of the region’s fastest-growing economies with an average growth rate of 5.9%, thanks in large part to prudent macroeconomic policies and structural reforms. Landers calls Peru “our favorite of the Andean markets right now.”
While the nation now has liquid capital markets for debt, backed by strong local financial institutions, the Peruvian stock market is not yet home to enough diverse companies to provide broad-based exposure to this economy,” says Wev from Clark Capital.
Indeed, the iShares MSCI All Peru Capped ETF (EPU), which carries a 0.63% expense ratio, has more than half of its $214 million portfolio tied up in mining stocks. Banks account for another 30%, which means that few other sectors have much representation in the Peruvian stock market thus far. But an ongoing economic expansion should help broaden out the market’s weightings and this fund’s exposure to the dynamic Peruvian economy.
Lastly, investors can cover the whole Andean region through the Global X FTSE Andean 40 ETF, which has a 0.72% expense ratio. The fund has just $4 million in assets, and has not yet fully resonated with investors. It owns stakes in the 40 largest and most liquid stocks in the region. Chilean companies make up more than 60% of the fund, a reflection of that country’s more mature economy.
Every decade or so, another emerging market moves into the fast lane by creating the platform for sustained long-term growth. Past examples include Japan in the 1950s, South Korea in the 1970s and Singapore in the 1980s. More recently, Chile, Colombia and Peru have been laying the foundation for long-term economic growth, while Argentina—with its new government, highly educated workforce, vast trove of natural resources and deep ties with European and Asian trading partners—is trying to position itself for an economic renaissance.
David Sterman has served as research director at several Wall Street firms and as managing editor of RealMoney.com, He is now an ETF industry analyst and also works as a financial advisor in New York State’s mid-Hudson Valley.