Posted inEmerging Markets

Spectre of left looms over Latam funds

South America map 3d illustration

Three of Latin America’s largest economies, accounting for roughly two thirds of the region’s GDP and population, go to the polls this year and the results could have profound implications on the region for years to come, says Matthew Holdgate, portfolio analyst at Nikko Asset Management. One issue is set to dominate the election schedule more than any other: corruption.

Colombia is first to the polls with the first round of presidential elections set for 27th May and for the first time in 20 years a socialist candidate has a chance of winning the presidency.

Mexico will be next to cast its vote with presidential and congressional elections scheduled for 1st July and where populist leftist Andrés Manuel López Obrador (Amlo) has a big lead in the polls

Finally, Brazil will hold presidential elections in October, amid heightened uncertainty. Former leftist President Luiz Inácio Lula da Silva (Lula) has been banned from running over corruption charges while right-wing populist Jair Bolsonaro is gaining support.

Columbia: socialism rising

In Columbia, socialist candidate Gustavo Petro‘s anti-establishment rhetoric has grabbed headlines with his plans to nationalise industry and reduce the country’s dependence on oil revenues. Petro – whose campaign has relied heavily on social media – is popular with young voters and is feared by businesses, who are quick to draw parallels with the late Hugo Chavez in neighbouring Venezuela.

Right wing challenger Iván Duque campaign is centred on a pro-business and pro-security programme which would look to cut taxes and roll back the most controversial aspects of the FARC peace deal. Other contenders include Germán Vargas Lleras from the centre-right Cambio Radical party and Sergio Fajardo, the centre-left former major of Medellin.

With polls showing a split of support across the four main candidates it is highly unlikely that any candidate will secure a majority in the first round at the end of May but if the strong support for Petro and Duque is maintained then they are likely to contest the second round on 17th June

“Petro’s candidacy remains a wild card, but our base case is that economic and security concerns will win out, particularly given the economic woes in neighbouring Venezuela, with Duque better positioned than Petro to win over voters supporting the more centrist candidates in the first round,” Holdgate said. “A Duque victory would be good news for the Colombian Peso and ensure that fiscal consolidation is at the forefront of government concerns.”

Mexico: anti-establishment frontrunner

Anti-establishment populist Andrés Manuel López Obrador (known as Amlo) leads the polls in Mexico by a wide margin, tapping into widespread public anger against the established parties. His main challenger is Ricardo Anaya of the centre-right Partido Acción Nacional (PAN) which has formed an unlikely coalition with the centre left Partido de la Revolución Democrática (PRD).

The third main candidate is José Antonio Meade, from the ruling PRI party, who is trying to distance himself from the corruption allegations that have dogged unpopular incumbent President Enrique Peña Nieto.

“The issue of corruption has defined the presidential race in Mexico, with both Anaya and Meade having been drawn into corruption allegations, boosting the Amlo’s chances,” Holdgate said. “We expect Amlo to secure the presidential vote this time given the extent of negative public sentiment towards the traditional party candidates.”

“Despite concerns surrounding Amlo, we do not believe that investors should panic. Amlo has moderated his policies significantly over the years, partly in order to make himself more electable, but also in recognition of the limits he will likely encounter in Congress.”

Amlo is unlikely to secure the two-thirds congressional majority needed to overturn constitutional reforms so a reversal of Mexico’s energy reforms is highly unlikely. Amlo has also moderated his stance towards NAFTA – he views Mexico’s economy as over-dependent on the trade pact – though he is likely to push hard for better terms for the agricultural sector.

“We expect volatility to increase as the election campaign intensifies, with some investors likely to disinvest from Mexican assets in the event of an Amlo win. However, we expect to see policy continuity on a number of measures including NAFTA and energy reforms clarified early on in his presidency. This will likely see investors return to Mexico, particularly given a combination of cheap asset prices, declining inflation and the removal of policy uncertainty,” Holdgate added.

President Peña Nieto’s scandal-ridden time in office has not helped Mexico-focused equity funds during the three-year period to end-March, according to FE Analytics. The worst performing European-domiciled Latam funds are focused on Mexican equities, including HSBC GIF Mexico Equity IC (-22.98%) and BTG Pactual Mexico Equity (-11.97%).

Brazil: uncertainty reigns

In October, attention will shift to Brazil, as the population elects a new president, as well as all 513 members of the Lower House, governors and state assembly members, and 54 out of 81 members of the Senate.

The composition of the next Congress will be key as the new representatives attempt to tackle much-needed pension reform in 2019.

“Given what is at stake for the future of the reforms and, therefore, the country, the next six months will be key for Brazil, and clearly a potential source of volatility. A market friendly outcome will require a government that is willing to stick to reform in order to generate a strong primary fiscal surplus and to help stabilise the debt trajectory,” Holdgate said.

Former President Luiz Inácio Lula da Silva (Lula), from the left wing Partido dos Trabalhadores (PT), is the leading candidate but the frontrunner has been barred from running after the courts upheld a corruption charge. Presuming his appeals against the ruling are unsuccessful, the field is wide open.

Right-wing Congressman Jair Bolsonaro – from the Partido Social Liberal (PSL) – is edging the polls in the absence of Lula. Bolsonaro is a controversial character, having advocated far-right views on a number of social policies. Despite this, Bolsonaro’s economics team, headed by Paulo Guedes, would likely pursue a number of liberal economic policies including privatisation and tax simplification.

On the left-hand side of the political spectrum Ciro Gomes from the Partido Democrático Trabalhista (PDT) looks poised to try to capitalise on Lula’s downfall. Gomes strongly opposes privatisation, and would likely obstruct the path to, or else dilute the impact of, pension reform.

Another leftist challenger is Marina Silva of the Rede Sustentabilidade (REDE) party. Silva’s platform is a pro-environmental one, opposing the deforestation of the Amazon. Like Bolsonaro, Silva also has a strong social media presence, with strong support amongst younger voters.

Last, but not least, is centre right São Paulo Governor, Geraldo Alckmin of the Partido da Social Democracia Brasileira (PSDB). Alckmin is a clear reformist and a clear proponent of pension reform. Alckmin’s centrist position would enable him to form coalitions across a fragmented parliament, and hence he would likely muster enough support to follow through on the reforms initiated by his predecessor.

The uncertainty surrounding Lula and who would pick up his votes in the likely event that he is unable to run makes predicting the outcome of the Brazilian election difficult.

“We are inclined to downplay the importance of opinion polls in Brazil at this early stage as campaigning has yet to start, hence voter recognition alone can play a significant role. So despite Alckmin’s currently poor polling results, should the improvement in the economy of late continue, with falling unemployment and low inflation, voters could begin to favour a candidate that represents the continuity of the current economic policy,” Holdgate said.

“We expect Alckmin to be competitive against both Gomes and Silva in facing Bolsonaro in the second round. Should Alckmin make it to the second round, we expect him to prosper as he has the broadest appeal of all candidates. We believe that expectations surrounding a market friendly candidate succeeding are already low, with potential for a positive surprise coming from Alckmin’s bid. Hence, our investment stance towards Brazil is currently one of caution.”

The performance of  Latam funds

The Latin America fund sector returned 7.16% over the three-year period to end March 2018, according to FE Analytics, buoyed by re-bounding commodity prices and Brazil’s return to growth following its recession. But uncertainty over the elections may have contributed to weakened returns over the last six months.

The top European-domiciled Latin America equity fund, Bradesco Brazilian Equities Mid Small Caps R, returned 40.27% during the three-year period. The fund saw a -3.58% decline in returns in March and returned 0.59% in the six months to the end of March. More than a quarter of its holdings are in consumer cyclical stocks.

Top European-domiciled Latam equity funds

 Source: FE Analytics

 

The second best performing fund, Investec Latin American Equity I returned 39.84% over the three years to end-March. But saw a -1.09% drop in March. 20.8% of the fund’s holdings are in financials with Brazilian equities making up 60.7% of its holdings, followed by Mexico (16.4%).

The Investec Latin America Smaller Companies fund, meanwhile, the third best performing fund, posted returns of 38.27% during the three-year period. It is also overweight on consumer stocks and focused on Brazil (58.1%) followed by Mexico (17.7%).

David Robinson

David Robinson is the editor of Expert Investor. He has 18 years’ experience as a business journalist and editor. In the past he has written for the Guardian newspaper and The Telegraph, and worked as...

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