Cast a net in the stabilised economies of Latin America

The Fund Manager: 'Private companies have always been well managed, but the problem has always been on the government side. What has changed now is that government economic management has improved'

By Keiron Root

By Keiron Root

11 October 2000

When UK investors think of Latin America, they usually have visions of hyperinflation, weak currencies and "banana republic" governments of dubious morality and little financial skill. But Rodrigo Pinheiro, manager of the Old Mutual Latin American Companies Fund, says that all belongs to the past.

Mr Pinheiro, born in Portugal, started as an analyst with local stockbrokers, after graduating in economics from the University of Oporto.

After three years in corporate finance, he came to England to study for an MBA at the Cranfield School of Management, then joined Old Mutual's UK operation as the analyst in Latin American markets.

Despite the changing reality, Mr Pinheiro knows there are big psychological barriers to British investors putting their money in the region. "Latin America has always had very good companies," he says.

"The private companies have always been well managed, but the problem has always been on the government side. What has changed now is that government economic management has improved and they are being supported by the electorate.

"Low inflation is the most important factor. People don't want hyperinflation, it makes them panic, so there is considerable public support for governments to bring inflation down and keep it down. The key thing is whether they can sustain this.

"I saw the effect of Portugal coming into the European Union, with interest rates falling from the mid-20s. The mentality of a country changes completely when you bring interest rates down by that much.

"Now, for example, Brazilians are experiencing nominal interest rates of 16.5 per cent for the first time in their lives, but the market is not reflecting these changes yet."

The focus of the portfolio is firmly on the main markets of the region, particularly Mexico and Brazil, which between them make up just under 80 per cent of the MSCI Latin America Free Index and around 87 per cent of the Old Mutual Latin American Companies' portfolio.

Mr Pinheiro says : "I manage the fund on a sector basis, looking at clusters of companies, since companies within the same sector can react very differently to things like interest rate changes.

"I concentrate on the big companies and we have about 43 or 44 holdings in a fund of around £15m." The largest holding is Telefonos De Mexico (Telmex) at just under 9 per cent, followed by the Brazilian oil stock Petrobras (8 per cent). No other stock accounts for more than 4 per cent of the total.

"Petrobras is interesting because it is trading at a 50 per cent discount to other major global oil companies and it is a stock I like. Telecom stocks are very cheap because the sector has corrected massively and I have been increasing exposure to Brazilian telecoms. These have very low ratings by international standards. In Mexico, I am keen on the banks. The market hasn't yet priced in the value of their involvement in insurance and pensions.

"You find companies in the region that are trading at much lower levels than similar companies in developed markets.

"These companies are cheap because they have a low cost of capital - stocks such as Grupo Televisa in Mexico, which is the largest Spanish-speaking media company in the world, with a very strong management and a strong and stable US dollar cashflow, or Telmex, the largest telecom company in Latin America, with links with Microsoft and SBC. It is a very efficient telco with one of the highest margins in the world.

"Then in Brazil you have CVRD, which is the largest iron-ore company in the world with the lowest cost of production, and Embraer, the world's fourth-largest manufacturer of commercial aircraft and the lowest-cost producer of regional jets, with links to major European aerospace companies. This is a stock that is currently on a very low p/e of nine times.

"Money is going almost exclusively into the big markets. There is a lot of political instability in smaller markets, Venezuela, Colombia and Peru and these are a long way behind the bigger markets.

"The oil price has been very good for Venezuela, but the political situation is so bad we don't know where the country is going."

Mr Pinheiro's fund has exposure to only two other markets, 7 per cent in Chile and less than 5 per cent in Argentina. "The trouble with Chile is that it trades more like a developed market - it is much more highly valued. Brazil and Argentina are connected markets and Brazil and Mexico are different.

"For example, if the oil price rises that is good for Mexico, as a producer, but bad for Brazil, as a consumer. Mexico is dependent on the US - it is really a 52nd state - but for the rest of Latin America what really matters is world growth.

"Mexico and Brazil have benefited from reforming policies for years and, as a result, their budget deficits are modest, inflation is better controlled and interest rates have been declining. Currency values have been generally stable, although Mexico and Brazil suffered crises in the Nineties.

"Brazil has managed the extraordinary feat of capping inflation at 8 per cent and bringing it back to below 5 per cent, despite 1999's major devaluation and the surging of oil prices.

"The fiscal deficit in Brazil was largely a social security problem and they have done remarkably well to bring this down. I did not think they could do it in such a short time."

A further encouraging factor is the significant increase in investment in the region by major global companies.

Mr Pinheiro adds: "Privatisation has meant multinationals investing a lot of money in the region and these are players who take a long-term view. They have been putting millions into Mexico and Brazil in particular.

"Brazil received around $30bn last year and a further $22bn so far this year. The multinational involvement also ensures governments stick to their reforming policies because they will take their investment away if they don't."