Top Latin America Fund Avoids Ibovespa in 2014: Corporate Brazil

The Euro Pacific Latin America Fund posted the best return among regional peers this year by selling Brazilian shares. Fund manager Richard Hoss says stocks from Latin America’s largest economy will continue to underperform.

The commodities boom that fueled Brazil’s 7.5 percent growth in 2010, the fastest in 25 years, has ended and shows no sign of reviving as demand from China slows, according to Hoss, who helps oversee $100 million in emerging-markets stocks at New Sheridan Advisors. The EP Latin America Fund he co-manages posted the best return and lowest volatility this year among 11 U.S.-based peers that focus on the region.

Brazil failed to bolster manufacturing and promote new industries as soaring prices for iron ore and pulp exports sparked a five-fold gain in the Ibovespa stock benchmark in the 10 years through 2012, Hoss said in an interview. The gauge, with a 39 percent weighting in commodities companies such as Vale SA and Petroleo Brasileiro SA, has dropped 26 percent this year in dollar terms, the most among 20 major equity indexes tracked by Bloomberg.

“Brazil, like other commodity-oriented economies before it, didn’t take advantage of the good times to diversify,” Hoss said by phone from Newport Beach, California. “These economies are in a certain way like pop artists. They are successful for a short period, but if they don’t create anything new and different after the big hit, they become a one-hit wonder.”

Government Intervention

The EP Latin America fund returned 1.8 percent this year, while the benchmark MSCI Emerging Markets Latin America index lost 16 percent, according to data compiled by Bloomberg.

Hoss boosted holdings of Mexican stocks to 53 percent from 39 percent at the end of last year, and reduced the stake in Brazilian equity to 23 percent from 32 percent, data compiled by Bloomberg show. By comparison, the MSCI index has 28 percent of its holdings in Mexico and 56 percent in Brazil. EP Latin America’s Brazil holdings gained 8.9 percent this year, while the Brazil holdings in the MSCI index lost 14.5 percent, according to data compiled by Bloomberg.

EP Latin America sold shares in Brazilian utilities and banks as the government increased intervention in the economy by demanding power companies cut prices and boosting subsidized lending by state banks to favored industries.

Mexico is on the cusp of opening up its economy by enacting a law that would permit foreign companies to drill for oil for the first time since 1938. Supporters of the plan brokered by the country’s two largest political parties say it will make Mexico the world’s fifth-largest oil producer in about a decade, from ninth place now, and spur growth in Latin America’s second-biggest economy.

Government Policies

The energy initiative in Mexico shows that politicians are able to cooperate for the greater good, a “positive for the country’s economy,” Hoss said. In Brazil, “we didn’t like the competitive environment for private-owned banks, as state-owned lenders have been acting according to the government’s priorities.”

Press officials for President Dilma Rousseff and BM&FBovespa SA, the manager of Brazil’s stock exchange, didn’t respond to e-mails seeking comment.

Mexico’s IPC index has slipped 3.2 percent this year, while the Ibovespa has slumped 18 percent in the same period. The Brazilian equity gauge slipped 0.1 percent today as of 1:55 p.m. in New York.

Cheaper Valuation

Brazilian stocks are more attractive now thanks to their cheaper valuation, according to Gabriel Wallach, who manages about $2.5 billion in assets as chief investment officer of global emerging-market equities at BNP Paribas Investment Partners. While IPC members trade at 17 times estimated earnings over the next 12 months, Ibovespa companies are valued at 10.3 times profit forecasts, according to data compiled by Bloomberg.

“It’s definitely a good time to switch from Mexico to Brazil on valuation and growth,” Wallach said in a phone interview from Boston. “We’re expecting Brazil to rebound in 2014, and Mexico doesn’t appear to have any strong catalysts for earnings growth.”

Hoss said he was able to ward off volatility in the fund by picking companies with positive free cash flow and low leverage ratios. Among the top five holdings are for-profit college Estacio Participacoes SA, which has posted 23 straight quarters of positive cash flows, and BM&FBovespa, which has the second-lowest ratio of debt to assets among the 72 stocks on the Ibovespa.

Investing Formula

“We evaluate the country scenario, sector prospects, and then we choose the highest-quality companies,” Hoss said.

The fund invests in companies with lower dividend yields than the benchmark MSCI Latin America index, higher price-to-earnings ratios, lower debt-to-equity figures and higher profit margins, data compiled by Bloomberg show.

Brazilian exporters such as jetmaker Embraer SA and busmaker Marcopolo SA will benefit from a weakening real, and education companies are poised to gain as spending on education increases, according to Hoss.

The real has depreciated 8.8 percent in the past six months, the worst performance among 16 major currencies tracked by Bloomberg. It will drop an additional 8.2 percent by the end of next year, according to forwards trading.

Brazil’s 0.5 percent decline in gross domestic product in the third quarter from the previous three months was the biggest contraction since 2009, according to data the national statistics agency released on Dec. 3. Economists in a weekly central bank survey forecast a 2.35 percent expansion in GDP this year, down from a projection of 3.26 percent in January.

Consumer Demand

“Manufacturers that are currently competitive in spite of Brazil’s high labor costs, high taxes and poor infrastructure should perform even better with a weaker real,” Hoss said. “Education is the way an underdeveloped nation can pave its way to become a developed country, so we expect Brazil to focus on that.”

While the currency’s decline benefits exporters, it will sap the purchasing power of Brazilian consumer, dimming the outlook for retailers and consumer-goods makers, Hoss said.

“The consumerism model that Brazil adopted to boost its economy over the past years in unsustainable,” he said.

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