Beyond Latin America's Political Sideshow: Equity-Income Plays For Savvy Investors

Contentious elections in Brazil and Mexico, as well as economic fallout in Venezuela and other countries, made headlines in Latin America this year. Those willing to look beyond the political maelstrom are finding attractive investment opportunities among stocks in diverse sectors set to capture growing domestic demand.

Latin American countries have captured a lot of negative attention recently as reports of election turmoil, trade tensions, and government power struggles make the news. But all too often, the cacophony of political machinations and drama of election cycles drown out the region's increasingly diversified investment landscape, improving economies, growing middle class, and resilient stock markets.

Much of the negative noise these days is coming from Brazil, where the success of presidential candidate Jair Bolsonaro, a polarizing right-wing figure, highlights the deep political fissures in the country and underscores growing anti-establishment sentiment. Venezuela, another country in the news, has been in the throes of an economic freefall, hyperinflation, and political upheaval.

Look beyond the headlines, however, and a different story emerges. Most countries in the region have established strong and stable governments managed by dedicated elected officials, or are on a path to doing so. Over the last two decades, for example, Columbia has moved from a haven for drug cartels and political corruption to a more country with a stable rule of law and sensible, centrist governments. Chile could also see continued broad, positive transformation with the recent election of a new regime.

In Mexico, Latin America's second largest economy, trade tensions that arose soon after President Trump's election have eased with the recent trade agreement among North American countries, which turned out make only minor adjustments to NAFTA. Earlier this year Mexicans overwhelmingly elected Andres Manuel Lopez Obredor (AMLO), a president whose left-wing leanings and calls for change resonate with the public. Since the election Lopez's comments have taken on a more moderate tone that appeals to with the private sector and many stock market observers.

Bright spots are also shining through even in Brazil, the region's largest and most liquid stock market. "Financial markets seem to be responding positively to Bolsonaro's well-regarded economic advisor," says Nick Robinson, Investment Director, Aberdeen Asset Management. "Pension and social security reforms are proceeding, inflation is in check, and the economy continues to recover."

A Diverse Economic Base

Robinson also points to an increasingly diverse economic base in the region. Less than two decades ago, the fortunes of many economies and stock markets in Latin America hinged heavily on the direction of commodity prices, and on a handful of large, state-owned enterprises that depended on them. While oil, gas, copper, and other commodities remain an important part of the economic base, Latin America has also become home to a growing number of companies in sectors such as financials, consumer staples, health care, and information technology. This change is reflected in the MSCI Emerging Markets Latin America Index, which was once heavily dominated by energy and materials companies. Today, such companies make up less than one-third of the index.

"From a political standpoint, Latin America is still a volatile region where elections can deliver surprising results," says Robinson. "But with a growing middle class, broader economic base, and increasing consumer demand it's also becoming a more stable one from an economic perspective."

Companies set to thrive in Latin America's new economy are expanding as poverty declines and economies grow. According to The World Bank between 2003 and 2016, the share of the population living in extreme poverty in the region fell from 24.5 percent to 9.9 percent. A recent report from the United Nations predicts that despite geopolitical risk economies in South America are expected to grow by 1.2 per cent in 2018, while Central America will notch 3.4 per cent growth.

The region's stock markets, historically dominated by foreign investors, are seeing increasing participation by domestic investors seeking to tap opportunities close to home. These local investors are bringing a new perspective to the market, and may prove to be a stabilizing force in the future. Companies are increasingly instituting more shareholder friendly policies through high standards for governance, accountability to shareholders, and financial reporting transparency. A growing number of them rely mainly on domestic demand, making them much less susceptible to trade wars, tariffs, commodity price shifts, and currency fluctuations than large multi-nationals.

Beyond Petrobras

Active management is an important component of stock selection process at Aberdeen. Instead of hewing closely to benchmark weightings and stocks, analysts and managers go beyond artificial boundaries to uncover the best opportunities in today's market. Over 75 percent of the portfolio of the Aberdeen Emerging Markets Equity Income Fund, a diversified closed-end fund that invests in income-producing emerging market stocks, differs from the benchmark index.

The fund's managers view volatility in Latin America and other emerging markets as opportunities to take profits or add to positions as appropriate. As bottom-up investors, they look beyond the political sideshows and other external events to focus on what they believe are quality companies with good growth potential. The holding period for stocks in the fund averages eight years, which keeps turnover costs low and testifies to confidence in their stock picks.

In the Aberdeen Emerging Markets Equity Income Fund, the Latin America exposure is focused on companies set to capitalize on increasing domestic demand. One holding, is a Brazilian a software company specializing in a variety of point of sale applications for gas stations, convenience stores, supermarkets, restaurants, and other retail environments. Robinson likes the company's expansion possibilities, as well as recurring monthly fee revenue from customers who use its software. In Mexico, a franchise fast food restaurant, is meeting the growing demand for casual dining.

On the other hand, the fund's underweight position relative to benchmark index in large state-owned enterprises in the region provides a buffer against government interference and commodity price swings. Earlier this year, a lack of exposure to state-owned Brazilian oil company Petrobras, a ubiquitous holding in most emerging market funds, proved to be a positive influence when shares fell on investors' concerns over continued government interference in pricing policy.

Why Aberdeen?

Aberdeen Emerging Markets' structure as a closed-end fund also offers a potential advantage for investors. Unlike a traditional open-end mutual fund, which continually issues or redeems shares based on investor demand a closed-end fund issues a fixed number of shares to investors and does not issue new shares. If supply exceeds demand for those fixed shares, their market price will sell at a discount to net asset value. If demand exceeds supply, shares will trade at a premium. When shares are selling at a discount, as they are now, it provides a "value kicker" that could benefit shareholders when the discount narrows, or shares trade at net asset value or higher.

Headquartered in Aberdeen, Scotland, and with 46 offices in 24 countries, Aberdeen Standard Investments is uniquely positioned to capitalize on the world's most promising global opportunities, regardless of where they originate. With $735.5 billion under management, as of June 30, 2018, across diverse asset classes, the firm delivers original thinking and proprietary research that few companies can match.

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