Brian Jacobsen

Investing in South America (excerpt)

On the Trading DeskSM4-17-13
By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist

Where are the investment opportunities in South America? What is there to avoid? What are the risks? Derrick Irwin, portfolio manager on Wells Capital Management’s Emerging Markets Equity team, provides perspective in this excerpt of On the Trading DeskSM from Friday, April 12, 2013. This follows up on the previous edition, Understanding South American Economies, featuring guest expert, William R. Cline, Ph.D., senior fellow at the Peterson Institute for International Economics.

Watch the full interview.

I’d like to begin this interview where we left off last week with Dr. Cline’s interview, where he expressed a caution in terms of investing in that region—government intervention, volatility in the exchange rates, and the economic ties that many of these countries have to China and Europe.
Well, I think he’s pretty well spot-on, identifying three of the big risks. From an equity investment standpoint, I think of the three, what we’re most concerned about is the sustainability of investment-led demand from China, which has driven demand for basic materials and many of Brazil’s major exports over the last decade. And we need to understand, as that investment-led growth slows down, how does that impact Brazil? Now, we think, going forward, Brazil, being the largest market in South America, has its own internal demand and internal growth dynamics that will eventually take over, but it will certainly be a rocky transition.

The opportunity set. You’ve brought three names to consider. First is Ambev.
It’s the dominant brewer in Brazil, with about a 70% market share, with operations in many smaller South American countries where it has a very strong market share as well. Attractive because it has a dominant market, but there’s a lot of room for growth left in terms of premiumisation, where people buy more expensive brands of beer. It’s a great example where the compounding growth opportunities, over the years, are laid out in front of us very clearly.

Staying in Brazil—Cetip. Who are they and what do they do?
They’re involved in the registration and custody of fixed-income and derivative securities in Brazil, so very much a niche market. And the corporate fixed-income and derivative market in Brazil is very, very small. Traditionally, fixed income has been dominated by Brazilian government debt, but as interest rates have come down and inflation has stabilized in Brazil, we think the corporate-debt market will grow dramatically over the next 10 years. Cetip, being the dominant registrar of these securities, has a great competitive position that will only grow as that market grows.

Fascinating. Now, let’s move into Colombia and to Bancolombia. Who are they and what do they do?
Bancolombia is one of the leading banks in Colombia, as its name would suggest, and we really like the Colombian market. The fundamentals of Colombia are very strong; it’s quite a fast-growing economy, in very good shape. It’s come a long way from how many people perceive Colombia. But in terms of the banking system, it remains largely underpenetrated, so consumer debt or overall bank debt to gross domestic product (GDP) is only about 30%, versus almost 50% in Brazil and, of course, much higher than that in China or places like the United States. So there’s a very long runway for companies like Bancolombia to continue to see strong growth in lending in Colombia.

Colombia was one of those countries Dr. Cline mentioned being more free-market oriented with its politics. How is it that these three companies reflect your approach to investing?
First, we’re looking for high-quality companies, and I think these three companies really tick that box quite well—dominant market share, excellent growing industries, and able to defend their market share quite robustly. Second, what we’re looking at is: Can they generate long-term compounding growth? And, finally, are they available at a compelling discount to our assessment of their intrinsic value? And although we would value each of those companies much differently, each of them is trading at what we think is a compelling valuation.

So we’d like to move now to Venezuela, which was one of the countries that Dr. Cline had mentioned, along with Argentina, that they may be more populist in terms of their policies. So let’s talk about Venezuela, especially since the passing of Hugo Chavez. [For my current analysis on the outcome of the Venezuelan presidential election please read: China and Venezuela: Part of the emerging markets slowdown story.]
The good news, very technically speaking, is that Venezuela is technically what they call a frontier market versus an emerging market. It has not yet graduated to emerging market status, in part, because of the political problems they’ve had. I don’t see us getting involved in Venezuela anytime soon. Its economy is very, very fragile; it’s effectively been hollowed out under Chavez, and there’s no indication that whoever takes over afterward is going to change direction.

A parting thought?
We’ve had a lot of questions about the performance of emerging markets, which have underperformed developed market indices quite dramatically in the first quarter of the year. People ask, do we think the emerging market story is over? I think the answer is a resounding no. The underperformance in the first quarter was a readjustment of some valuations that had become distorted through 2011 and 2012, and, in my view, quite a healthy adjustment. We think the fundamentals of most emerging markets remain very strong and the long-term investment outlook remains excellent. We’re looking forward to another strong decade in emerging markets.

Derrick, thank you for joining us.
Pleasure, thanks for having me.

The views expressed are as of 4-17-13 and are those of Chief Portfolio Strategist Brian Jacobsen; Derrick Irwin; and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.


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