On the day that the British Prime Minister ordered the most draconian measures seen during peacetime in Britain, it seemed appropriate to pen some thoughts on the current environment. Given the rapidly changing environment it’s difficult, if not impossible to know what happens next. What’s said here could look very foolish in two weeks, or even in two days’ time.
Recent market moves have been huge with 10%+ daily swings not uncommon. Since the peak in early January 2020 the MSCI EM Latin America Index is down 46.8% GBP and 51.5% in EUR with Brazil down even more than this1. Currencies across the region including the Mexican Peso, Chilean Peso and the Brazilian Real have collapsed with investors fleeing to the relative safety of the US dollar. We are witnessing very challenging times, which in a Latin American context is not something we say flippantly given the history of economic booms and busts across the continent.
Some of these large market moves should not come as a great surprise. Over the last four calendar years Brazil was one of the best performing emerging markets rising over 188% in GBP and over 150% in EUR1. It was only in January this year we vividly recall the exuberance of many sell-side participants who were falling over themselves to highlight the length and depth of the forthcoming initial public offering (IPO) pipeline and the wall of money that was ready to participate, despite what we saw as extremely high valuations. Market participants had once again become carried away with the promise of much needed reform under President Bolsanaro and history tells us this has never been easy, especially in a place like Brazil.
Unlike many previous crises in Latin America, the COVID-19 pandemic is global in nature and originated outside the financial and economic system. It’s a public health and safety emergency, and given we know so little about it or how long it might last makes it difficult to draw on the past to forecast the future. Although initially a health crisis it’s quickly becoming an economic one, with governments and central banks reacting rapidly, and we are seeing measures implemented on a day-to-day basis in an attempt to contain the health, financial and economic impacts. It’s interesting to observe that the Saudi-led oil price war which has undoubtedly fuelled some of the volatility hardly gets a mention in today’s mainstream press.
At the time of writing the number of confirmed cases of COVID-19 in Latin America was relatively small compared to many other regions, with Brazil and Ecuador the most affected with 25 and 15 deaths respectively2. The region however, is probably a week or two behind much of the world so we can expect these numbers to accelerate, and to do so rapidly.
As already alluded to, Latin America is no stranger to a crisis and unlike many others in the past it’s been encouraging to see most governments learning from the rest of the world, taking early, proactive and in some cases extraordinary measures to try and contain the spread of the virus. Chile and Ecuador have introduced curfews and more will follow.
Brazil has started to close down businesses and restrict movement, despite a lack of support from President Bolsanaro. He has disagreed with many state authorities’ decisions to close businesses, called São Paulo Governor João Doria a “lunatic” for imposing a 15-day shutdown, and described the reaction as ‘hysteria’. Mexico’s President, Andrés Manuel López Obrador, has so far ruled out any curfew or troop deployments, saying this would be too authoritarian3. However in Mexico City, the mayor is closing museums, gyms, bars, theatres and similar public venues until at least 20 April4.
Chile is a country where we have for many years unearthed a number of high quality ideas for the Fund. Despite it being in the news for all the wrong reasons for much of the past six months (social unrest and riots on the street) it remains one of the only countries in Latin America with a relatively lowly geared5 government balance sheet hence is much better placed to implement measures needed in seeing out this crisis when compared to many of its neighbours. Brazil was struggling with debt repayments after its Petrobras-related crisis6 and recession even with interest rates at an all-time low, whereas the nearly USD100 billion debt of Mexican state-owned energy company Pemex trades at distressed levels7.
Portfolio performance and positioning
Our investment philosophy has not changed in thirty years. We aim to invest client money in high-quality, well-stewarded, resilient businesses with the aim of preserving capital. As we have noted frequently in the past, a decade of ultra-loose monetary policy8 has inflated valuations across the globe dangerously. As a result our strategies are positioned conservatively hence we would expect them to perform robustly during any market crash, and while we hate losing money for clients we would describe recent performance in this strategy as acceptable.
Year to date to 23 March, the Latin American Fund was down 30.5% (GBP – Class A shares) and down 30.4% (GBP – Class B shares). The Fund was down 36.3% in EUR (Class B shares). This compared to the MSCI EM Latin America Index which has fallen 45.1% in GBP and 50.3% in EUR9.
As we’ve seen in crashes of the past, the first phase of the downturn can see indiscriminate selling with all companies being sold at the same rate, regardless of their quality or their fundamentals. This time is no different. Some businesses with net cash balance sheets have fallen as quickly as their heavily indebted counterparts, and some equities trading in January at reasonable valuations fared little better that others with eye-watering valuations. However we remain confident that in the medium to long run this will resolve itself, most likely as and when companies start to post financial results (for the better companies) or seek refinancing (the remainder).
Positives in the short year so far include a number of companies we own on behalf of our clients continuing to do well despite the environment: Raia Drogasil, a Brazilian pharmacy chain with 100 years of history, national coverage and a conservative balance sheet, and WEG, a family run Brazilian industrial company that makes electric motors should prove to be defensive holdings in the portfolio. Another company that we have owned for many years and where we continue to have high levels of conviction is FEMSA, a consumer goods company based in Mexico that continues to reinvent itself, continues to grow and we are confident will remain relatively defensive.
There are of course investments that haven’t done as well and we don’t want to shy away from these. Although we didn’t own an airline or a hotel company, our net cash online Argentinian travel agency, Despegar has been caught in the eye of the storm with global travel grinding to a halt. It has fallen over 60% in the last three months and it is unclear when it will book its next customer’s international flight. Some of the few companies we own with reasonable amounts of debt are unsurprisingly struggling. This includes Ultrapar, a Brazilian conglomerate which is primarily involved in fuel distribution, gas storage and petrochemicals and more recently expanded into retail and pharmacies, taking on debt in the process. We will continue to review the situation with these companies in line with our approach and consider their long-term future in the portfolio versus the conviction we may have in newer ideas trading at more reasonable valuations.
Hindsight is a wonderful thing and any new investments made on behalf of clients over the fourth quarter have proven disappointing in terms of timing. Our recent investment in Falabella is especially frustrating given it has fallen more than 50% in the last few months. The company is a conservative, family-owned Chilean retailer which includes DIY stores and a consumer bank. We have known the company for many years but until late last year it had always been too expensive for us to own. The Chilean riots and subsequent market weakness gave us an opportunity to initiate a position. We remain confident in the long-term opportunities for the business and are happy to retain and add to our holding10.
In terms of recent activity we are spending a lot of time on conference calls with management across the region, and although it doesn’t replicate face-to-face meetings it’s an adequate substitute. Regarding the portfolio we tend not to make knee-jerk decisions, hence the number of transactions has been minimal. At the margin we are trimming some of the more expensive stocks that have held up well to invest in some of our favourite companies that have fallen to attractive levels, and we continue to review the companies we have on our radar.
The long term economic impact of the current crisis is unknown, however we can assure you our approach remains consistent. We continue to look for resilient, high-quality, cash generative businesses that having remembered previous crises will come out of whatever 2020 brings in a stronger position than less prepared peers.
To end on a more positive note we are starting to find many very good companies now trading at far more attractive valuations than we have seen in some time, and our cash levels allow us to take advantage of these opportunities.
Thank you once again for your continued support.
24 March 2020
Additional index performance
GBP - Class A Shares
GBP - Class B Shares
EUR - Class B Shares
These figures refer to the past. Past performance is not a reliable indicator of future results. For investors based in countries with currencies other than those shown, the return may increase or decrease as a result of currency fluctuations.
Source for fund: Lipper IM/Stewart Investors. Performance data is calculated on a net basis by deducting fees incurred at fund level (e.g. the management and administration fee) and other costs charged to the fund (e.g. transaction and custody costs), save that it does not take account of initial charges or switching fees (if any). Income reinvested is included on a net of tax basis. Source for benchmark: FactSet, income reinvested net of tax.