Latin America: still shaky after all these years

Are the days of political instability, protectionism and hyper- inflation over? Alison Eadie considers the continent's emerging markets

Emerging markets do not emerge in a smooth progression, eventually taking their place among developed nations. The history of Latin America demonstrates the pitfalls that can lie on the way.

In the 1920s and 1930s, Argentina was one of the world's richest nations, at one stage ranking fourth, ahead of Germany. Its relative decline has been precipitous, proving that more than a stock exchange is needed to make a successful emerging market. Strong domestic savings, fiscal and political stability and the encouragement of exports help.

Instead, Argentina and most other Latin American countries have had three decades of protectionism, political instability and hyper-inflation, which destroyed domestic savings and rendered them vulnerable to the whims of foreign capital flows. Only last year, Mexico's vulnerability was all too evident.

In recent years most Latin American countries appear to have got to grips with their problems. Chile, for example, is now heralded as the Singapore of Latin America. It produced gross domestic product growth of 8.5 per cent last year and is on course for 7 per cent this year.

It has a savings rate of 27 per cent, while private pension funds account for 40 per cent of GDP and 10 per cent of the stock market. It has privatised industries, liberalised trade and, like Singapore, is investing aggressively in its neighbours.

The country has also made an uneasy transition to democracy, although reform began under General Pinochet's dictatorship.

As one of the least naturally rich countries of the region, with copper and not much else, the Chilean model is encouraging to the rest.

Argentina instituted economic reforms some six years ago and already has inflation licked, at an expected 1.1 per cent this year. Peru, which has yet to embrace democracy, is similarly on track.

Brazil is still hampered by vested political interests, but the growth potential is there. And Mexico, after suffering the pain of devaluation following the debacle of 1995, is expected to enjoy corporate earnings growth next year, despite GDP growth being held back by the debt overhang.

So is this a good time to invest in Latin America? Fund managers are divided.

Foreign & Colonial, which helped finance the building of Latin American railroads in the 1880s, believes so and is "overweight" in investments in the region.

Emily McLaughlin, director of the Latin American desk at F&C, describes the region as "under-valued, under-owned and under-loved". Despite the choppiness of stock markets, projected 12-month returns look very attractive, she says. On fundamental grounds there is plenty of justification in being overweight, F&C believes, although there are short-term risks linked to wobbles on Wall Street.

Templeton, another fund manager, has been buying heavily over the past year, particularly in Argentina and Brazil.

Templeton Emerging Markets Investment Trust had 22 per cent of assets in Latin America a year ago, and now has 32 per cent after converting cash into stocks. Douglas Adams, marketing director, says the stock-picking approach has turned up a greater number of bargains in the region than elsewhere in the world.

By contrast, James Hancocks, manager of Guinness Flight's Emerging Markets Fund, prefers Eastern Europe and South East Asia. He sees Latin America as high risk because of uncertainty over economic growth and corporate earnings and is "underweight" in the region overall. However, he likes Chile and Brazil, where he is fully weighted.

Mercury, another top manager, is also underweight, while Morgan Grenfell is neutral.

Differences of opinion over individual countries are more pronounced than differences over the region as a whole. Templeton avoids direct investment in Chile because of capital gains tax problems, preferring to invest via companies doing business there or via New York.

At Guinness Flight, Mr Hancocks rates Chile as particularly attractive now that interest rates have probably peaked. Its stock market has fallen this year, but has been a safe haven in comparison with the Wall Street- inspired jitters in Argentina and Mexico in recent weeks.

Morgan Grenfell is underweight in Argentina because of its sensitivity to the US - the peso has a one-to-one relationship with the US dollar. But the company believes Mexico deserves credit for taking its medicine in the past 18 months, getting inflation down and exports up.

F&C believes investors have not appreciated the success of the reform programme so far and Argentina's improved risk profile. The only agreement between fund managers is on Brazil. Although it has yet to develop the fiscal policies it needs, its huge potential means managers love it.

Investors wanting exposure to Latin America can choose lower-risk global funds or regional unit and investment trusts run by F&C, Templeton, Morgan Grenfell, Save & Prosper, Old Mutual and more.

Going further up the risk scale there are a few single country funds. Genesis runs a Chile investment trust whose shares have risen 136 per cent over the past three years. F&C's Brazilian Smaller Companies investment trust has fared less well, rising 24 per cent.

F&C also manages European unit trusts dedicated to Argentina, Brazil and Mexico.

The smaller Latin American economies do not feature much in portfolios as yet. Peru is most favoured as it has instituted economic reforms, is growing strongly and building up domestic pension funds.

Colombia, unlike its neighbours, has never defaulted on its debt but suffers an image problem. Its stock market is cheap for those prepared to take the risk. Venezuela is unpopular as it has relied heavily on its oil and is too state-dominated.

Further down the track lie Ecuador, Bolivia - the poorest Latin American country but trying its hand at privatisation - and one day perhaps, Cuba.