Latin America is seen as a hotbed of political disruption and volatility, but there are ways to generate a smoother ride in the region.
• Latin America is an exciting place to invest, but investors need to find a way through the volatility
• Combining equities and bonds gives us more levers to manage risk through the cycle
• Latin America today is seeing considerable reform and economic improvement
There are many compelling reasons to be invested in emerging markets: growth is stronger, investors are better compensated for political risk, and many countries are seeing significant economic reform. In contrast to the developed world, inflation is moderating across emerging markets, which means interest rates are falling. Economic growth is accelerating, just as the developed market recovery is starting to look increasingly mature.
This is all very well, and many investors understand the value of emerging market exposure in their portfolio, but it does not help them mitigate the associated volatility. Emerging markets are always, to some extent, buffeted by global investor sentiment and tend to exhibit extremes of valuation. The Brazilian benchmark Bovespa index, for example, has almost doubled since the start of 2016 (https://www.bloomberg.com/quote/IBOV:IND), but has seen a prolonged period of weakness prior to this resurgence.
This is part of emerging market investment and it is impossible to guard against this completely. However, there are a number of measures we take in the Aberdeen Latin American Income Fund to mitigate this volatility.
Most importantly, we combine equity and fixed income. This allows us to generate yield using the fixed income side, ‘freeing’ the equities side to be more flexible. We don’t have to rely on company dividends to provide the income for the trust and don’t have to invest in low growth areas. This gives us more levers to adapt to different market conditions. While the portfolio is split approximately 60% equities to 40% fixed income, it will vary where we see opportunities.
For example, Latin American is just emerging from a difficult period. Today, inflation is moderating, interest rates are falling and corporate earnings are starting to pick up on the equity side. As such, we want to have more equities. The income focus is in itself protective, meaning investors get paid to wait for share prices to grow.
Also important, in our view, is to have a focus on quality companies. We want to uncover the best quality companies in the region and invest in them. In finding those companies, we conduct bottom-up company analysis with a team of analysts in the region. We want to find those companies with a strong business model, managed by a capable team, with sound cash flows, making distributions to shareholders.
That said, while we are prepared for shocks, those shocks do not look imminent in the region at the moment. No doubt they will come again, and investors should be prepared, but for the time being there has been a notable swing from the left-leaning politics to a more market-friendly approach. Argentina has President Macri; Dilma Rouseff was impeached in Brazil and has been replaced with a more market-friendly administration. The same has happened in Chile, Columbia and Peru.
The taming of inflation across the region has also been important. In 2016, double digit inflation was commonplace across the region, but today inflation has moved closer to central bank targets and interest rates have moved lower as a result. Brazil saw its benchmark interest rate cut to 7.5% in October, having been at 14.25% a year ago. (https://www.reuters.com/article/us-brazil-economy-rates/brazil-signals-record-low-rates-with-slower-cuts-ahead-idUSKBN1CU310).
Brazil remains the largest position in the trust, in both equities and bonds. We are seeing a significant turnaround in the Brazilian economy, and any enduring political risk is priced into markets.
The notable exception to the generally positive trend has been Venezuela, which has suffered an economic and political meltdown. This is tragic for the country itself, but is unlikely to have significant contagion for the rest of the region. Venezuela had long been isolated economically from the rest of Latin America.
Mexico also gives some cause for concern. An election next year may see the populist candidate, Andrés Manuel López Obrador, come to power and this could be destabilising. More importantly from our point of view, the market is very expensive and there are risks around how the North American Free Trade Agreement renegotiations will play out. Where we have exposure to Mexico, it is selective.
In our investment approach, macroeconomic analysis of countries and economies blends with microeconomic analysis. It is impossible to leave the macroeconomic analysis aside in a region such as Latin America, but on the other hand corporate business models are vitally important, alongside the strength of individual companies’ balance sheets and the ability to generate profits.
Investors still feel Latin American is a shaky region, subject to recurring political crises. This is not picture we draw from investing there. If investors can look through the political noise, the region is seeing significant and enduring reform, its governance is improving and there are plenty of exciting investment opportunities for the long term.
Aberdeen Latin America Income Fund aims to provide investors with a total return, with an above average yield, through investing in Latin America through a diversified portfolio of equities and fixed income investments.
Risk factors you should consider prior to investing:
• The value of investments and the income from them can fall and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company's assets will result in a magnified movement in the NAV.
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company's shares.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
• Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
• There is no guarantee that the market price of the Company's shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company's shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
• Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
• With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘sub-investment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1YG. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.
Find out more at www.latamincome.co.uk