Investors streamed into Latin American stock markets early last year to load up on bargain-priced shares in a bet that the region's economies would shake off three years of miserable performance and begin to recover. Their wager paid off. Latin American growth returned, and by year-end regional bourses had rocketed 67 percent higher in dollar terms, besting both Asian and European emerging-markets' performance. Brazil's stock market jumped 103 percent, edging Argentina's 99 percent and Chile's 80 percent. Even laggard Mexican shares leaped 30 percent.
"Low U.S. interest rates were by far the most important driver of the rally in 2003," explains Dario Lizzano, Santander Investment Securities' New Yorkbased research director. Foreign investors were willing to brave Latin America's notoriously volatile markets, which had dropped by a total of 41 percent in dollar terms over the previous three years, because the yields on low-risk U.S. government bonds hit 40-year lows early in 2003. In short, buyers needed to look further afield to generate better returns; investors, following the advice of early bulls like Lizzano, shifted $375 million into Latin American funds last year, the first time in three years they were net buyers, according to data compiler EmergingPortfolio.com Fund Research.
Unfortunately, Lizzano and his fellow Latin America analysts haven't had much time to savor their success. U.S. interest rates have already begun to rise as inflationary pressures mount, and at least some overseas investors no longer think the region is worth the risk. The MSCI Latin American index has eased by 10.5 percent in dollar terms this year through mid-May, and investors have yanked a combined $109 million back out of Latin funds. In mid-May the Brazilian Treasury had to cut the size of its weekly auction of floating-rate notes because of weak investor demand; it had had to cancel its previous debt sale altogether.
"There is a fundamental tension between global investors retrenching and Latin economies doing much better in terms of economic management," says Mario Epelbaum, New Yorkbased Latin America equity strategist at Morgan Stanley. "Will this violent withdrawal of capital tip over these countries? Probably not, but the probability is not zero. What will likely save most of the big countries is the fact that their economies are managed better today."
The insights of leading Latin specialists like Lizzano and Epelbaum are as critical to investors in today's higher-risk environment as they were before last year's impressive bull run. Which Latin markets and companies can prosper as the global economy shifts? Which governments will stray from sound fiscal management? And just how do the region's prospects compare with those of emerging markets in Asia or Europe?
The brokerage firm investors turn to most often for answers to these and other important questions is UBS, which takes top honors in Institutional Investor's 2004 Latin America Research Team. Securing first place for the second year in a row, UBS garners 15 team positions, up from 14 in 2003. Bear, Stearns & Co., which gains one team slot for a total of 12, repeats in second. Santander Investment Securities climbs a notch to third.
Latin research at virtually all these firms has undergone radical changes in recent years as the region's total market capitalization has fallen from $260 billion to $139 billion, owing to foreign acquisitions and poor markets. Whereas only a few years ago most major brokerages had discrete research units largely based in Latin America, today their regional analysis is most often part of a global emerging-markets team run from New York or London.
"The key is to strike the right balance between having a strong local presence and a wide global outlook," says Merrill Lynch's Latin Research Director Dan Lubash, who also co-heads the firm's global emerging-markets analysis. "Investors are looking for both." From London, Lubash oversees 11 analysts on the ground in Latin America and eight more in New York who travel frequently to the region. The group constantly assesses relative values among Latin, Asian and Eastern European companies and markets. Other firms use variants of this model, emphasizing, say, local analysis more heavily or global comparisons in just a few industries. Still others have chosen to integrate Latin research into their U.S. equities teams.
The global emerging-markets research model addresses buy-side needs for worldwide comparisons. Louis Carrillo, portfolio manager for Latin American funds at J.P. Morgan Fleming Asset Management, with more than $1.6 billion of Latin equity investments in its regional and global portfolios, says he favors UBS's research work in part because the firm excels at cross-regional studies, "such as comparing a Mexican company with a South Korean one," which is vital to his own analysis.
Many analysts provided examples of the kind of in-depth knowledge that produced outstanding research. Four-time first-teamer Marc McCarthy (who leads the No. 1 team in Conglomerates and the No. 3 in Oil, Gas & Petrochemicals this year) of Bear Stearns suggested in a research report last August that Alfa Group, a Mexican conglomerate, should spin off its 90 percent stake in loss-making steel unit Hylsamex by creating a separate tranche of "junior equity" that would trade alongside Hylsamex's existing shares and monetize some of the value from its stake. Validating McCarthy's assessment, Alfa executives in January of 2004 announced a two-part sale (this year and next) of its Hylsamex shares. Anticipation of a spinoff, coupled with Hylsamex's improving sales performance, has helped push Alfa's stock 67 percent higher since McCarthy's report. "He got the Alfa story exactly right," says Mark Jason, senior analyst at Houston's Aim Investments, which has $125 million in Latin equities.
Investors certainly have taken note of analysts' accomplishments in 2003. On a scale of 1 to 10, buy-side voters awarded Latin America researchers an average score of 6.9, up from 6.6 last year. In 2004, 27 percent of those expressing an opinion thought research had improved in the previous 12 months, whereas in 2003 only 9 percent saw an improvement.
Of course, investors may look even more critically at Latin research performance this year if higher rates set back the region's recovery. For now, most analysts think Latin America's generally more disciplined fiscal policies will allow it to weather any upcoming storms. "Obviously, 2004 will not end up as spectacular as 2003, but we still see attractive valuations and strengthening economies driving the market upward," says Mexico Citybased Damian Fraser, who leads UBS's Equity Strategy and Mexico teams to first-place finishes for the third year in a row.
Portfolio manager Carrillo of J.P. Morgan concurs: "There is nothing fundamentally wrong with the market right now. In fact, economies are much stronger than in previous years when we saw crises," he says. "While exogenous factors such as the interest rate in the U.S. might affect risky assets in general, there is nothing intrinsic in the market that would lead to a repeat of previous crises."
The rankings were compiled by Institutional Investorunder the direction of Assistant Managing Editor for Research Lewis Knox and Senior Editor Jane B. Kenney with Associate Editor Sivert Hagen.