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Latin
lover ? May 2003
Felix
Krantz, manager of the DBLA Latin Bond Fund, tells
Alaric Nightingale why the sector’s fundamentals are looking
healthy?
Suppose you woke up one morning charged
with the task of making £5,000 rise in value by as much as possible
in one day. What would you do? Would you head to an exclusive shopping
district to buy a piece of jewellery or would you go to a jumble sale
armed with an antiques encyclopaedia?
If you do the former, you know you will find an attractive jewel that,
with luck, you will be able to resell, but you will almost certainly
make a loss. It is, of course, at the jumble sale that you are more
likely to find a bargain.
This is arguably a principle that runs through all areas of investment.
Are investment bargains easily identifiable in established, G7 economies
that are flooded with capacity and inventory, where price/earnings
ratios are feted when they fall below 20, and where every other wealthy,
global investor has the vast bulk of their assets allocated?
Undoubtedly there are bargains to be found in these economies –
and like in exclusive shopping districts, there is probably less risk
of buying worthless junk. But if you really want to make money, you
might be better off looking at countries that are under-capitalised
and being shunned by other investors.
Currently, and despite six good months, the biggest jumble sale in
the world’s financial markets remains Latin America.
The region has been beset by one serious problem after another. It
started in Argentina. The country, which had been in recession for
over a decade, finally defaulted on debts in excess of $120 billion
at the end of 2001.
The fallout from Argentina was felt shortly afterwards in Brazil as
investors feared – perhaps incorrectly – a contagion effect.
It then got worse, as investors sold because a far-left politician,
Lula da Silva, became clear frontrunner in the race for the country’s
presidency. Then there was chaos in Venezuela, with a failed coup
d’etat and ongoing union conflict, which severely damaged oil
supply. Smaller countries, notably Uruguay, also suffered from the
difficulties their neighbours encountered.
But, as we said at the outset, the best place to find bargains is
often in places where others no longer want the assets and will get
rid of them at almost any cost.
So is Latin America a place to pick up investment bargains? The answer
may well be yes, but if you don’t know what rubbish you are
looking at in the jumble sale, and you can’t be bothered to
find out for yourself, then you need an expert to do it on your behalf.
Felix Krantz, fund manager of the DBLA Latin Bond Fund, may be such
an expert. He manages a $122 million fund, which was launched way
back in 1992. It is the largest – by far – of eight Lipper
Global offshore funds to invest specifically in Latin American bonds.
Structurally, the fund is a Luxembourg-domiciled Sicav (Société
d’investissement à capital variable). Minimum investment
is $5,000. The hugely disappointing part for many global investors
is that, to access the fund, you must be a client of Dresdner Bank
Latineamerika, for which you will need to commit $500,000.
If that doesn’t put you off – and we pass no comment at
all on DBLA, but recognise that it will not be everyone’s choice
of bank – there is a load charge of up to 3.5 per cent and total
charges work out at 1.125 per cent annual. Krantz has only been running
the fund for one year, but has worked at DBLA for a decade.
Krantz, like all fund managers everywhere, is upbeat about his own
region’s prospects. “In the short to medium term we continue
to have a positive outlook. The rally that we have seen for the past
six months happened faster and to a higher extent than we would have
estimated.
“We were not surprised by the duration but we did not think
it would happen this fast. The fund is up 12 per cent for the first
quarter of 2003. I don’t expect this to continue at the same
pace for the rest of the year.
“For the year-end I would expect the fund to be further up from
today’s levels, based on what we see on the fundamentals side
and also on the flow side. Inflows into Latin American debt markets
are at a very high level.”
Krantz’s fund invests exclusively in Latin American fixed-income
products but can also have a cash holding. One of the main reasons
why the fund was set up in 1992, was to demonstrate the bank’s
dedication to the region via a sector-specific product rather than
a broadly based emerging market bond fund, which is a more common
approach by asset management firms.
In terms of absolute performance, it has fared solidly, despite the
bad times. Over ten years to end 2002, it has put on 110 per cent
or 7.7 per cent annualised. More importantly, for those whose aim
is capital preservation, the fund has recorded small gains over the
past one and two years, while the region has been at its most volatile.
But the truth is that you should not be investing for past performance.
You should be investing if you believe that Latin America’s
investment horizons are brightening – and you should understand
the inherent risks of that assumption.
Certainly, in terms of weightings, the fund’s key exposure is
to Mexico, where it has a weighting of 35.5 per cent of its assets
(against the JP Morgan Eurobond index weighting of 46.1 per cent),
which looks pretty attractive. Mexican banks – despite a meltdown
in 1994 and 1995 – now look in pretty good shape. They are lending
more and more to private business, and demand for Mexican paper has
been rising, forcing down yields in recent months. Moreover, on a
strategic level, Mexico is becoming more and more important to the
United States, because of its oil reserves.
The fund’s next biggest weighting, Brazil, 30.5 per cent, will
be more controversial in many investors’ eyes, particularly
given an LEI index weighting of 20.3 per cent.
But Krantz is confident that this is a solid play, especially given
the fact that Brazilian government dollar-denominated debt –
supported heavily by the International Monetary Fund – with
a 2004 maturity, is currently yielding 6.4 per cent.
The crucial question – the only fundamental question –
is how high is the default risk on such bonds? “I would put
the short-term risk of a default at almost zero,” Krantz says.
“The IMF has committed a great deal of money to Brazil.”
But Brazil remains a risk for two reasons. The first reason is obvious:
there is risk either of a default or, more importantly, risk that
fears of default could bring prices down. The second risk is simply
that fixed income globally will fall from favour if stock markets
globally pick up in any meaningful way (the jury is out on this one).
Nonetheless, Krantz says there is a lot of investor interest for a
number of pretty straightforward reasons. “There is continuing
demand. Spreads in Latin America look pretty attractive, compared
to the high-yield corporate sector in the US, and particularly in
comparison to the high-quality investment sector.”
“We believe the positive capital inflow into Latin America will
continue. In the very beginning, after Argentina’s default at
the end of 2001, we saw some kind of decoupling, especially in Brazil,
although fears that risk would spread prevailed. These fears proved
to be right.
“Towards the middle of last year, with Brazil getting close
to the election, there was contagion. People started looking at the
news and there was this political uncertainty. Especially foreign
and institutional investors started exiting the asset.”
Risk premiums on Brazil’s external debt reached 2,500 basis
points and were trading almost at distress levels as it became more
and more obvious that Lula was poised to win the election.
But Krantz feels the reaction was overdone. “Capital markets
seem to find the right trends in the long term but exaggerate them
in both directions in the short term. They exaggerated them on the
way down, but when they found out it wouldn’t be wiped off the
planet, this trend was reversed quite fast.
“In the very short term, we see geopolitical uncertainties.
I think that the market might be ready for a pause. A lot of people
have huge profits, especially institutional investors, and some will
be tempted to secure some of their profits.”
A second, important question is how Krantz and his predecessors interpreted
the market’s difficulties at the time of Brazil’s crisis.
“We were heavily invested in Brazil all the time. We reduced
this when the crisis deepened. Our approach is more top down. We tend
to look at the macro and political situation and break that down into
trade-related issues.”
The truth is, though, that those who stuck with Brazil appear to have
been proved correct, given that the default risk seems to have abated.
A more interesting question is whether those who were invested in
the country should have made their decisions based on market sentiment
above economic fundamentals.
“But we were uncertain as well. If you continue to think Brazil
will be fine and you are alone and prices continued to go down, you
start to wonder. Our economics department held a constructive view
on Brazil all along, however, they realised that if you are alone
in your view, then you better be right, otherwise you have a serious
problem.”
That episode is history. The fact is that there is now a broad (if
possibly temporary) consensus that Latin America has stabilised. Even
Argentina is improving from very low levels, Brazil has done better
than most global investors dared hope after the elections, and Mexico
has rarely looked so healthy. Time, perhaps, to visit one of the world
market’s biggest jumble sales.
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