BlackRock Latin American (BRLA) invests in Latin America for capital growth, using the full extent of BlackRock’s resources as the world’s largest money manager to generate alpha from stock selection and proprietary macroeconomic analysis.
Since 2018, BRLA has also paid a quarterly dividend set at 1.25% of NAV, equivalent to 5% at a constant NAV. The board can pay this out of capital where necessary, which means the managers can continue to focus on the best growth prospects without having to sacrifice growth for yield.
Managers Ed Kuczma and Sam Vecht took over in January 2019. Their aim has been to make the portfolio more active, with individual stock picks more important to performance. As we discuss in the Performance section, this has generally been successful, although the region has been rocked by two major crises during the managers’ tenure.
The MSCI EM Latin America benchmark is dominated by Brazil (c. 61%) and Mexico (c. 24%), and BRLA’s portfolio is similarly weighted. The region’s markets were among the worst hit by the coronavirus pandemic with a c. 45% peak-to-trough fall. The index is now trading on extremely low P/E levels and BRLA is on a 10.3% discount (see the Discount section).
The only two other closed-ended funds investing in Latin America are arguably sub-scale (with net assets well below £50m). As a result, their charges are double BRLA’s. With open-ended funds also rare, BRLA is one of the few options for exposure to the region, and benefits from the advantages of closed-ended funds such as the ability to gear and not having to sell into falling markets.
In US-dollar terms, the Brazilian stock market is at a similar value to what it was in 2005, despite the huge advances the economy has made since then. In our view this is anomalous, and the market could be an intriguing long-term investment. There are also some headwinds: the high exposure of the market to energy, materials and financials means it is cyclical, exposed to the global economy and biased to value. However, all this means that it could be a strong performer in any recovery from the global pandemic crisis – just as it was one of the hardest hit entering the crisis.
BRLA is a highly attractive way to access this opportunity. Its closed-ended peers look sub-scale after the vicious drawdowns of recent weeks, and BRLA is now extremely cheap by comparison. Furthermore, it offers an attractive yield from a region to which few investors will have any exposure (we note that the region is less than 10% of the MSCI Emerging Markets Index, so few investors will have exposure through their EM funds).
Finally, the experienced management team and deep resources of BlackRock have the potential to be a potent combination. We note that the trust has become demonstrably more active under Ed and Sam, with strong evidence they can add alpha against the benchmark – even if that has been derailed in the short term by unpredictable crises.
|The trust is on a wide discount and the market is extremely cheap||The fallout from the coronavirus pandemic is unpredictable in the short term|
|A 1.25% quarterly dividend||Latin American markets can be extremely volatile|
|An experienced management team with deep resources to draw on||Any increase of gearing brings greater exposure to falling markets as well as rising markets
BlackRock Latin American (BRLA) is managed by Ed Kuczma and Sam Vecht, who aim to generate capital growth ahead of the MSCI EM Latin America Index through a mixture of stock selection and economic and political top-down analysis. Since they took over in January 2019, the portfolio has become more active, with fewer stocks and higher conviction in the stock-picking. The pair use BlackRock’s extensive resources to enable them to draw on the widest possible number of inputs, with company visits, access to top-tier decision-makers in the region and extensive quantitative resources employed to an extent which would not be possible for many other money managers.
Under the current managers, the management of the portfolio has become more integrated into BlackRock’s broader emerging-markets team. The team builds models for each economy, aiming to understand where it is in the business cycle and how asset prices are likely to develop. The managers then aim to tilt their portfolio towards countries which are earlier in the cycle, subject to finding attractive stocks. Alongside this analysis, Ed and Sam focus in particular on the four ‘C’s for understanding how attractive the individual countries are on a macroeconomic basis. This is a framework Ed has developed over his 15 years working in Latin American equities, and is made up of commodities, currency, consumption and credit. Understanding the trends in these four factors helps the managers to tilt the portfolio to stocks with the winds behind them.
The stock-selection process aims to identify high-quality companies with strong management teams. When we spoke to Ed recently he stressed the importance of that latter characteristic, given the tendency of Latin America to suffer periodic crises. There is a huge body of evidence as to how different companies have handled difficult episodes which Ed believes helps him to identify those companies which are likely to be long-term winners and come out of challenging situations in stronger competitive positions. To that end, the access that BlackRock is able to get to company management and other key stakeholders and authorities in their countries of listing is extremely useful in forming a judgement.
As we illustrate in the Performance section, the early evidence is that this process can add alpha in the normal course of events, even if it clearly cannot predict and prepare for unexpected events like the current coronavirus pandemic.
The index is dominated by Brazil, which makes up roughly two-thirds of its market capitalisation. Ed and Sam have been overweight to this country since taking over management. The country has enjoyed a steady decline in interest rates from mid-double digits after its last recession, which has encouraged investment in its stock market at the expense of its debt and boosted the real economy. Added to this, a reformist president, Jair Bolsonaro, has managed to tackle what had seemed an intractable problem for the public finances with extensive pension reform. Bolsonaro has also aimed to reduce state involvement in the largest Brazilian companies, which Ed and Sam believe should encourage better returns for shareholders. The chart below shows the trust’s position at the end of December, i.e. before the crisis hit.
Of course, all macroeconomic views have to be revised in light of the coronavirus pandemic. When we spoke to Ed recently he told us that the selling in the region had been indiscriminate. Mexico (to which BRLA was also overweight) held up better than Brazil thanks to the defensive constitution of its stock market, which is dominated by consumer staples and other low-beta industries. Brazil was one of the worst-hit countries in the world. The managers have taken some profits in Mexico, having benefitted from their overweight position, and are looking to reinvest in high-quality Brazilian stocks, which are now much cheaper. That said, the managers believe that Mexico will be a long-term winner from this crisis, with many US companies likely to re-shore manufacturing there at the expense of China.
Ed believes that many of the quality companies they own will come out of this period of crisis in a stronger competitive position in their industries with the potential to be more profitable over the course of the cycle. The managers are scouring the balance sheets of their holdings to ensure they are durable, paying particular attention to cash levels, and looking to raise their allocations to the strongest. To that end, we understand the gearing levels could tick up in the coming week. Similarly, the weighting to Brazil should be rising from the level shown above at the expense of Mexico. Ed and Sam also think Peru and Chile are looking interesting at these levels, and so they have been raising their exposure to copper miners there.
Over half the regional index is made up of financials, energy and materials, which give the region a ‘value’ tilt which has not helped it in the current environment. However, BRLA offsets this slightly by being overweight to growth areas such as consumer discretionary and industrials. In consumer discretionary, the managers have recently bought into Lojas Renner, a retailer with a strong e-commerce offering. We note that e-commerce retail has done relatively well in the pandemic-inspired sell-off, as we discussed in a recent strategy note.
BRLA’s ability to pay dividends from capital means it can take positions in companies in growth areas which don’t pay a dividend and moderate the exposure to value which an equity-income portfolio often has to feature. The chart below shows the sector allocation prior to the pandemic (as at the end of December). Ed tells us that he has found exciting opportunities to add to cheap banks which could see the weighting there rise. Similarly, copper miners are also looking attractive, which could see the weighting to materials rise. The other major area of value Ed is finding is in real estate, where he and Sam are focussing on adding to the larger players which they think will benefit from the advantages of scale in a tough environment.
The next few months are going to be difficult for all economies. Ed notes that the central bank in Brazil has cut rates to 3.75% in response to the crisis. This and the fall in the Real making local assets cheaper abroad, should encourage local and international investors back into the market (subject to the government’s response to the pandemic). Admittedly, government responses have been disjointed so far in both Brazil and Mexico, with the leaders slow to accept the seriousness of the situation. Nevertheless, valuations on a P/E basis at the end of March were at lows last seen briefly in 2011 and before in the fallout of the 2008 crisis, according to Bloomberg numbers. In our view, a huge amount is therefore baked into the price and the region. The region tends to be highly geared to the global economy and could well be one of those to rebound the fastest and furthest.
Ed and Sam use gearing tactically, having agreed with the board that 5% will be considered a neutral level. They have tended to use gearing counter-cyclically. After the market falls in late 2019, they raised gearing to above this neutral level (c. 10%), and it remained there until the market rallied strongly in November and December 2019, after which they cut gearing back to neutral. When we met with Ed recently he told us that the trust had taken gearing down below 0% (i.e. the trust was net cash) in January and February. Following the sharp falls in March, Ed and Sam are looking to increase gearing in the coming weeks and months, adding to their preferred holdings, which they think were sold off indiscriminately in the crash.
The board expects gearing levels to fluctuate between 5% net cash and 15% net geared, although 25% is the maximum permitted without asking shareholder permission. Gearing is employed through an overdraft facility, which affords the managers flexibility in adjusting their market exposure. The company pays LIBOR plus 1%.
Ed and Sam took over management of BRLA in January 2019. The graph below shows performance since then, with the orange line representing cumulative relative performance vs the MSCI EM Latin America benchmark. The picture is one of steady outperformance being derailed by two crises out of nowhere. First, in August 2019, Latin American markets were rocked as the leftist candidate in Argentina came out of nowhere to defeat the pro-business president against all opinion polls and predictions, raising expectations that the country would default on its debt. The Argentinian market, to which BRLA was overweight, lost 50%. Then, in February and March 2020, came the coronavirus pandemic.
performance over managers' tenure
When we spoke to Ed recently he highlighted that Latin America has been prone to crises in recent decades, and investors in the region have to adapt to this. We think that notwithstanding the effects of the shock crises, the performance of the new managers has been promising and suggests their stock-picking can indeed add value. The rolling one-year tracking-error graph below indicates that the new managers have certainly brought a more active approach to stock-picking, accompanied by a fall in the number of stocks in the portfolio, which increases their chances of adding significant levels of alpha over the long run.
The five-year returns are less useful for assessing the current iteration of BRLA under the new managers. However, they do illustrate that their market has tended to be more volatile than other emerging markets (using the sector-average NAV return of the AIC Global Emerging Markets sector as the comparator). Latin America rallied particularly hard in 2016 thanks to currencies strengthening from record lows. Since then a gradual lowering of interest rates in the major market of Brazil and the election of a pro-business, liberalising president in that country have been tailwinds for the stock market. For the record, the five-year NAV total return of -18.7% compares to -15.6% for the MSCI EM Latin America Index.
The negative performance is due to the vicious drawdown suffered by the region’s stock markets in the coronavirus-inspired sell-off. The Latin American indices were the worst hit, with peak-to-trough losses of over 45%. Ed tells us that the indiscriminate selling has created opportunities for him to add to his preferred high-quality stocks at cheaper valuations. Gearing is likely to increase in the coming weeks too, we understand, as Ed and Sam aim to take advantage of the dramatic falls which seem to us to have created an interesting long-term entry point.
One of the key attractions of BRLA is the dividend. Since the second quarter of 2018 it has paid out 1.25% of NAV each quarter, paying out of capital if necessary. This would amount to a dividend yield of 5% if NAV did not move over the year. We stress that while the historical dividend yield on the current share price is 8%, this is misleading as there have been large falls in NAV since the previous quarters’ dividends were paid. Future dividends will depend on the NAV at the end of the respective quarters and will therefore be lower in pounds and pence than they were in 2019. Another factor affecting dividend payments is that the trust is managed in dollars, and so dividends must be converted back into pounds. As the below chart shows, there has been substantial dividend growth in the market in recent years which has bolstered the revenue account. However, over half the payout last year came from capital, which implies a running yield on the portfolio of below 3%. One of the key advantages of paying income from capital is that the managers are not forced to buy companies of lesser quality purely for the yield, and can maintain exposure to faster-growing businesses which may not pay as high a dividend. A good example of this is Lojas Americanas, a Brazilian retailer with a strong e-commerce offering, which Ed and Sam bought into at the end of 2019 even though it yields less than 1%.
Since January 2019 BRLA has been managed by Ed Kuczma and Sam Vecht; they took over from their colleague Will Landers, who had managed the trust since 2006. Ed is a Latin American specialist with over 15 years of experience investing in the region, and he leads Latin America research at BlackRock. He worked on the portfolio alongside Will for three years before taking over as co-manager. Ed works from New York alongside three analysts dedicated to the region. Sam is ‘pod leader’ for EMEA, Frontiers and Latin America, and co-manager of the BlackRock Frontier Markets and BlackRock Greater Europe investment trusts, as well as open-ended funds investing in both regions. Sam’s appointment alongside Ed, is one way that the Latin America trust has become more integrated into the wider BlackRock Emerging Markets team.
From speaking to the managers, we understand Ed to be more of a ‘companies’ man and Sam to be more focussed on the macroeconomic and political issues in the region, although both managers bear equal responsibility for all buy and sell decisions. Both are highly experienced emerging-markets investors and, in our view, their different experiences complement each other well.
As well as the dedicated regional analysts and the input of the sector specialists from the wider GEM team, who can provide context and analysis of global industries and supply chains, Ed and Sam can also draw on a dedicated big-data team. The GEM analyst on this team can use bespoke software and systems to analyse real-time data to provide extra insights, for example using robots to crawl the web and uncover insights about spending choices made on portfolio companies’ websites. As we discuss in the ESG section, the GEM team have also hired a dedicated ESG professional, who aims to help them integrate ESG issues within their investment process.
With the exception of the second half of 2019, in which the Brazilian market in particular performed very strongly and, we would argue, global optimism was picking up, BRLA has persistently traded on a double-digit discount. The Latin American markets were the hardest hit in the coronavirus-pandemic sell-off, and since then discounts have been volatile on a daily basis (not helped by the time-zone difference between the markets of investment and the London Stock Exchange on which BRLA’s shares trade), with the trust fluctuating between a discount of around 5% and over 10%. At the time of writing the discount is 10.3%.
In our view, there are two reasons to be positive about the current discount as an entry point. The first is that Latin America has proven itself to be highly exposed to global risk sentiment thanks to the structure of its economies and markets (over 50% of the Brazilian index is made up of financials, energy and materials). This means that the trust could do as well on any global recovery as it has done badly in the global sell-off. On top of BRLA’s share-price discount, the cheapness of the underlying markets means that overall this is a striking value opportunity. According to Bloomberg data, on a forward and historical basis the P/E of the MSCI Latin America Index fell to just over ten at the end of March. The last time it was this low was during 2011, which saw the eurozone crisis and precipitous falls in commodity prices, and prior to that in the fallout from the 2008 crisis.
The second reason to be positive is that the trust has strong discount-control mechanisms. There is a biannual continuation vote, with the next one due at this year’s AGM in June. There is also a four-yearly conditional tender offer, which could allow shareholders to redeem up to 24.99% close to par in 2022. The current period of calculation ends on 31 December 2021, with the tender offer to be put to shareholders at the 2022 AGM if two conditions have not been met. These are that the trust has outperformed its index by 100bps annualised, and that the discount has been on average less than 12%. The board noted in the recently published annual report that the first continuation vote was passed in 2018 and it has had no indication that shareholders’ views on the trust have changed since then.
The board has not bought back shares in recent years, preferring to lean on the continuation votes, tender offer and dividend policy to keep demand for the shares high. We think that makes sense in such volatile markets in order to maintain a sufficiently large pool of assets – following the recent market drawdowns of almost 50%, the trust’s sector peers are well below the size at which many investors will be able to invest, and the charges have correspondingly become very high.
The ongoing charges are extremely cheap compared to the trust’s two peers in the AIC Latin America sector. The 1.1% OCF is approximately half the 2% charged by the other trusts. This demonstrates one of the benefits of scale: at £116m of net assets, the trust is much larger than Aberdeen Latin American Income (with £29m) and JPMorgan Brazil (with £17m). In fact, given the small size of BRLA’s peers, it is arguably the only investable Latin American trust for professional investors. The management fee is 0.8% of NAV and there is no performance fee. The KID RIY is 1.51%, close to 100 basis points cheaper than that of the two peers (although methodologies may vary).
BlackRock’s emerging-markets desk have been increasingly integrating ESG processes into their investment thinking, and the team welcomed a dedicated ESG professional in 2018. As a company, we understand that BlackRock wants to be a leader regarding ESG issues, using its power as a major shareholder to encourage good practice. Governance is the biggest focus for the emerging-markets teams, in particular the treatment of minority shareholders. However, BlackRock also uses its shareholdings to question companies on social and environmental issues. One recent example of a social issue in the Latin American portfolio is Grupo Aeroportuario del Pacífico in Mexico. The company has been facing protests by activists claiming that some of their land was illegitimately purchased; BlackRock has been engaging to understand the validity of these concerns, which we understand seems limited at best.
With regard to environmental issues, following the Brumadinho dam disaster at a Vale iron-ore mine, BlackRock has been encouraging the company to ensure that its response and compensation is sufficient. Similarly, since the outbreak of fires in the Amazon the team have worked through the portfolio to ensure they did not have any exposure to companies involved in activities responsible for the fires. Ed has also personally met with Brazil’s minister of the environment to get an overview of the country’s response to the fire outbreaks.