Lots to Love in Latin America

Argentina has inaugurated a new pro-market president, Mauricio Macri.

Venezuela has elected a two-thirds congressional majority in opposition to leftist President Nicolas Maduro.

And Brazil’s parliament has introduced a resolution of impeachment against its leftist president, Dilma Rousseff.

In short, Latin America’s governance appears to be improving rapidly – and that means there must be a decent chance that its economic performance will improve, as well.

Fortunately, there are a few good ways for U.S. income investors to play this trend.

Most Latin American countries have suffered to some degree from declining commodity and energy prices, but only some have added management mistakes to their problems.

Argentina’s 12 years of spendthrift populism and Venezuela’s foreigner-hostile socialism are the most extreme cases. But even in Brazil, a tradition of excessive government spending – far higher than in most other middle-income countries – has finally caught up with its government.

Mexico, on the other hand, is showing signs of accelerating growth (in spite of the decline in oil prices) after Pemex’s operations were opened to foreign participation.

Elsewhere, Colombia enjoys good management and greatly increased political stability. Both it and Chile should enjoy accelerating growth in 2016 after a period of slower growth in 2014-15, according to the International Monetary Fund (IMF).

Meanwhile, all Latin American currencies have declined sharply against the dollar. The Mexican peso has dropped by 15% in the last year, the Chilean peso has declined by 12%, the Colombian peso declined by 28%, and the Brazilian real has dropped by 31%.

That has allowed some Latin American companies to enjoy large earnings gains, especially if they’re exporting in dollars and have costs largely denominated in local currency.

It has also meant that the small “hedged” Latin American exchange-traded funds (ETFs) – like Deutsche X-Trackers MSCI Brazil Hedged Equity Fund (DBBR), a $3.5 million fund whose assets are hedged back into dollars – have outperformed conventional funds.

Bulk Up on Brazil

By buying into Latin America today, investors are essentially making two bets:

  1. That the recent improvement in Latin American governance will continue, allowing finances to be brought under control.
  2. And that commodity prices will stabilize.

For that reason, I wouldn’t buy hedged ETFs, which will make losses if the currencies recover and are also still too small for safe investing.

Unfortunately, there’s no high-dividend ETF focused on Latin America, although the fund manager Recon Capital is in the process of creating one with a balance between Latin American markets.

Luckily, there are high-dividend ETFs focused on Brazil, which looks to be a good bet for a rebound, and Colombia, a well-run country whose currency has dropped sharply. Finally, there’s also a prime Chilean bank with an attractive dividend as a third possibility.

The Market Vectors Brazil Small-Cap ETF (BRF) seeks to match the Market Vectors Brazil Small-Cap Index. This $71 million fund has a very attractive 7.8% yield and a very competitive expense ratio of 0.59%.

Naturally, it has performed badly in 2015, with its price down 45% in dollar terms, but with sentiment on Brazil so sour and the currency zapped by a threatened ratings downgrade to below investment grade, there must be room for a rebound.

At this stage, if the Brazilian Congress succeeds in impeaching President Dilma Rousseff in 2016, the market would probably soar.

The Global X MSCI Colombia ETF (GXG) is a $57 million ETF seeking to match the MSCI All Colombia Capped Index. Like the Brazilian ETF, it has suffered a bad 2015, down 42%, but its yield is very attractive at 5.6% and its expense ratio very reasonable at 0.66%.

Colombia is a well-run country, with a diversified resource base that, since 2012, has had a trade treaty with the United States. Like the Brazilian fund, this one is poised to rebound, but without Brazil’s political risk (the capable President Juan Manuel Santos is in office until 2018).

Finally, Banco Santander-Chile (BSAC) is the Chilean affiliate of the Spanish multinational Banco Santander. It operates 476 branches and has a return on equity of a very healthy 19.7%. Its dividend yield, based on its most recent year, is 6.4%, and it’s trading at a modest price-to-earnings (P/E) of 10.9 times.

Chile has historically been the best run and least corrupt of the Latin American countries. While it has suffered recently from the decline in copper and other metals prices, Chile is forecast to grow at over 2% in 2015 and 2016, according to the IMF.

BSAC is thus a solid blue-chip holding with a very attractive dividend yield.

Bottom line: Latin America may seem like a high-risk place to invest, but given the sharp improvement in political climate over the last couple of months, it’s a region where even a conservative U.S. income investor should seriously consider putting some money.

Good investing,

Martin Hutchinson

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Argentina has inaugurated a new pro-market president, Mauricio Macri. Venezuela has elected a two-thirds congressional majority in opposition to leftist President Nicolas Maduro. And Brazil’s parliament has introduced a resolution of impeachment against its leftist president, Dilma Rousseff. In short, Latin America’s governance appears to be improving rapidly – and that means there must be...

Martin Hutchinson