BlackRock Latin American Investment Trust — Celebrating its 30-year anniversary

While the Latin American equity market has not kept pace with the global market over the last five years and can be volatile at times (Exhibit 2, LHS), there are reasons for optimism. Brazil is by far the largest economy in the region, and although growth disappointed in 2019, there is potential for increased economic activity in 2020. Interest rates have come down significantly in recent years; the Selic (central bank target rate) is now at 4.25%, down from 14.25% in 2016, and inflation is under control. The Brazilian government is also undertaking a broader programme of reforms, following the approval of pension reform in October 2019, which should lead to significant cost savings in the country.

Global markets have experienced volatility so far in 2020 due to the outbreak of the coronavirus (COVID-19). While this will undoubtedly have a negative impact on global growth, Latin American economies that are net exporters to China should be somewhat insulated, as their Chinese exports as a percentage of GDP is relatively low.

Latin American equities continue to be attractively valued compared to the world market. The Datastream Latin America Index is trading on a forward earnings multiple of 13.2x, which is a 18.1% discount to global equities, wider than the 10.2% average discount over the last five years. The potential for higher economic growth and relatively attractive valuations in Latin America may interest global investors seeking to diversify their exposure away from more expensive developed markets such as the US or Europe.

BRLA was launched in July 1990 and has been managed by BlackRock since March 2006. Its shares are quoted, in sterling, on the Main Market of the London Stock Exchange, while its financial statements are reported, and its NAV quoted, in both US dollars and sterling. Co-managers Sam Vecht and Ed Kuczma were appointed on 24 December 2018, following the departure of former manager Will Landers. Vecht is a managing director in BlackRock’s global emerging markets equities team and Kuczma is a director in its global Latin America equity team. They aim to generate long-term capital growth and an attractive total return from a diversified portfolio of companies whose shares are listed in, or whose main operations are in, Latin America. The trust’s performance is benchmarked against the MSCI Emerging Markets Latin America Index.

Investment limits dictate that BRLA’s exposure to Brazil, Mexico, Chile, Argentina, Peru, Colombia and Venezuela are each a maximum plus or minus 20pp of the benchmark index weights (other countries are plus or minus 10pp). At the time of investment, up to 15% of the portfolio may be in a single company; the fund may not hold more than 15% of a company’s market cap; and a maximum 10% of BRLA’s gross assets may be invested in unquoted securities. Derivatives may be used for efficient portfolio management or to reduce risk (covering up to 20% of the portfolio), and currency exposure is unhedged. Net gearing of up to 25% of NAV is permitted in normal market conditions with the aim of enhancing returns. BRLA’s board considers 5% of NAV as a neutral level of gearing over the longer term, and borrowing is utilised actively in a range of 5% net cash to 15% geared (at the time of drawdown). At end-January 2020, the trust held a 0.7% net cash position.

We met with Kuczma, who is very optimistic about the prospects for Latin America in 2020. Notwithstanding near-term uncertainty following the COVID-19 outbreak, he expects economic growth to improve from a somewhat disappointing 2019. Low interest rates are supportive for equity prices and Latin American currencies are depressed compared with the US dollar; a weaker dollar could be a positive driver for stock markets in the region.

Focusing on the individual Latin American countries where BRLA is invested, the manager says that in Chile, 2019 ended on a sour note due to social unrest, which is borne of the disparity in income levels. The political and corporate elite were receiving favourable tax rates and subsidies and the middle class said ‘enough is enough’, leading to protests and damage to infrastructure. The government announced fiscal reforms, including increasing taxes for the wealthy; however, Kuczma suggests that rewriting the constitution is like opening Pandora’s box, as it will lead to much uncertainty in terms of business confidence and growth, which could take a couple of years to work through; he believes this is not fully priced in to the market. BRLA’s performance has benefited from an underweight exposure to Chile. The manager says that valuations in the country were already relatively high, and with lowered growth expectations, despite the market sell-off, multiples are now even more elevated.

BRLA has benefited from its overweight exposure to Mexico. There is policy uncertainty regarding the government’s aspirations for growth against a fiscally conservative budget and hawkish monetary policy. However, Kuczma comments that Mexico has one of the highest real interest rates in the world, which provides the central bank with the potential to reduce the cost of borrowing and stimulate the economy. He notes that equity valuations in Mexico are very attractive compared with historical averages, and the market is under-owned. The manager suggests there could be positive surprises in the country; there is a national infrastructure development programme, which should stimulate growth, and the minimum wage is increasing by 20%, which should boost consumption and help ward off social disruption. President Obrador has high approval ratings, which is beneficial for consumer confidence, while the revised US, Canada and Mexico trade agreement could lead to higher levels of US foreign investment in Mexico.

Kuczma also highlights BRLA’s exposure to Brazil. The stock market had a strong run late in 2019, and the manager says that this momentum has continued into this year, so he is taking profits in stocks that have exceeded their price targets. However, he argues that higher-than-average equity valuations in the country are somewhat justified, as government reforms have led to lower country risk (measured by lower prices for credit default swaps) and interest rates have declined dramatically in recent years, which is supportive for future economic growth. The manager’s initial read on the Q419 earnings season in Brazil is positive, helped by lower interest rates; as an example, there has been an acceleration in the top-line growth of the retail and other consumer discretionary sectors. Companies that took advantage of the downturn in Brazil in mid-2014 to 2016 to rationalise their cost bases are now benefiting from operating leverage as growth resumes.

Kuczma has become more bullish on the prospects for Colombia; he notes resilient economic growth in 2019, which he expects to continue in 2020, driven by domestic consumption, while interest rates should remain stable as inflation is within the central bank’s target range. BRLA has an underweight exposure to Peru, due to political instability and depressed private investment. While there is a lot of uncertainty in Argentina, which is renegotiating its debt package with the International Monetary Fund, the manager suggests the speed and success of this process will dictate the direction of the stock market. BRLA has an overweight exposure to the country as Kuczma has found attractive investment opportunities in the commodity space, including Ternium (a steel manufacturer with significant operations in Mexico) and YPF (a major energy company).

Vecht and Kuczma select stocks following thorough fundamental research. They seek companies with a quality management team; positive fundamentals in terms of good long-term earnings growth, strong cash flow generation and a robust balance sheet; and an attractive valuation. The managers say that a consideration of a company’s environmental, social and governance (ESG) credentials is an important element of the research process, and has led to improved stock selection in the fund.

Since taking over management of the trust, Vecht and Kuczma have adopted a higher-conviction, more concentrated approach, with a more tactical use of gearing. The number of holdings has reduced from c 55 to c 40, yet the concentration in the top 10 holdings has also been coming down, as the managers have been increasing the weighting of some of the smaller positions in the fund. They invest across the market cap spectrum, with an investible universe of c 250 names compared with c 110 in the benchmark. Around 70% of the portfolio is held in companies with market caps greater than $10bn, but BRLA has a higher small/mid-cap weighting versus the benchmark MSCI Emerging Markets Latin America Index. Portfolio turnover in 2019 was higher than the typical 4060% pa as the managers repositioned the fund into their high-conviction ideas.

In terms of the macro backdrop, the managers take four ‘Cs’ into consideration:

While stocks are selected on a bottom-up basis, there are a number of themes in the portfolio:

Structural growth – these businesses can thrive throughout the economic cycle. Examples include e-commerce, which is underpenetrated in Latin America versus developed markets; healthcare, where demand is rising, helped by the expanding middle class; and a structural shift towards convenience stores.

State-owned entities (SOE) improvement – portfolio holdings include Banco do Brasil, Electrobras and Petrobras. Their managements now have a greater focus on profit and the rights of minority investors, which offers the potential for higher valuations over time.

Operating leverage beneficiaries – during the last recession in Brazil, companies took the opportunity to right-size their cost bases, so an upturn in sales could lead to a significant improvement in earnings, such as in the airlines, beverage and house building sectors.

Bond proxies with attractive valuations – as interest rates have come down, long-duration assets have been re-rated. The managers focus on companies that continue to have attractive valuations and generate predictable cash flows, such as in the airport, railroads and utilities sectors.

At end-January 2020, BRLA’s top 10 positions made up 48.8% of the portfolio, which was a lower concentration compared with 55.3% a year earlier; seven positions were common to both periods. Over this time, the trust’s largest changes in geographic exposure were a 4.6pp increase in Mexico, a 4.3pp increase in Colombia and a 9.5pp decrease in Brazil. BRLA’s meaningful deviations versus the benchmark at end-January 2020 were overweight exposures to Mexico (+4.8pp) and Argentina (+2.8pp) with an underweight to Chile (-5.4pp).

In terms of sectors, the largest changes were a higher weighting in real estate (+3.3pp), with lower exposures to financials and materials (both -4.6pp). There is a notable underweight in the financials sector (-4.8pp versus the benchmark).

Lojas Americanas has been added to the fund. It is a Brazilian retailer offering a very wide assortment including consumer electronics and fast-moving consumer goods. The manager suggests the company is a best-in-class operator, which will benefit from higher consumption and growth in its online operations. Lojas Americanas has a wide store network that supports the logistics for its e-commerce business. Two other new positions in the portfolio are Gol Airlines and Walmart de México y Centroamérica (Walmex). Gol operates in Brazil; the bankruptcy of a competitor has led to an increase in available capacity and a more rational pricing environment. Walmex benefits from stable demand and a high and growing market share, helped by good execution of its business strategy, optimisation of its cost base and continued investment in every-day low pricing.

Kuczma highlights a successful switch within the fund in the mining sector, with the proceeds from the sale of Antofagasta (Chile) being reinvested in Southern Copper (Peru). Recent sales within the fund include Enel Chile (an electric utility that had reached the manager’s price target; he also anticipates higher corporate taxes), Gerdau (a steel company that is under margin pressure), and Qualicorp (a healthcare services provider, whose share price had appreciated meaningfully).

As shown in Exhibit 8, BRLA’s relative performance has improved following the Argentinian stock market sell-off in August 2019. The trust benefited in Q419 from its overweight exposure to Brazil including companies such as Qualicorp (health plans) and B2W (e-commerce). BRLA’s performance was also enhanced by the tactical use of leverage. Kuczma highlights that the trust has continued to modestly outperform in 2020, with its focus on domestic growth within Latin America, despite stock market volatility because of macro issues including tension between the US and Iran, the US-China trade dispute, and the COVID-19 virus outbreak. BRLA has now outperformed its benchmark over the last three, five and 10 years in both NAV and share price terms, while its share price has also outperformed over the last year, which has led to a higher valuation (see the following Discount section).

BRLA’s discount has narrowed meaningfully in recent months, which Kuczma suggests may be due to increased marketing of the trust in H219. He says the messages he is receiving from investors are that they appreciate BRLA’s more concentrated portfolio and the managers’ high-conviction approach, along with the tactical use of gearing; he is hopeful the trust’s valuation can continue to improve. The current 8.8% share price discount to cum-income NAV compares with the 6.0% to 16.8% range of discounts over the last 12 months and the decade-high 20.6% discount in late October 2018. It is narrower than the 11.6% to 13.1% range of average discounts over the last one, three and five years.

The board employs a discount control mechanism aiming to reduce BRLA’s discount volatility. Subject to the biennial continuation votes in 2020 and 2022 being passed, a 24.99% tender will be triggered if the trust underperforms its benchmark by greater than 1% pa over the four years ending on 31 December 2021, or if BRLA’s average share price discount to cum-income NAV exceeds 12% over this period.

BRLA is a conventional investment trust with one class of share; there are 39.3m ordinary shares in issue. It has an overdraft facility for up to $40m with Bank of New York Mellon, at an annual rate of Libor +1%. Gearing is permitted up to 25% of NAV; at end-January 2020 there was a 0.7% net cash position, versus a historical range of modest net cash to c 12% geared. The managers are strategically adjusting BRLA’s level of gearing to take advantage of market volatility; for example, in July 2019 it was at the higher end of the historical range, but is now ungeared given the uncertainty brought about by the COVID-19 epidemic and higher equity valuations in Brazil.

BlackRock is paid an annual management fee of 0.80% of NAV (charged 75:25 to the capital and income accounts respectively). There is no performance fee. The latest available ongoing charge is 1.03% in FY18 (8bp lower year-on-year).

The trust is subject to a two-yearly continuation vote; the next is due at the May 2020 AGM.

BRLA’s board introduced a new dividend policy effective from July 2018, aiming to narrow the trust’s discount by making it more attractive to income-orientated investors. A regular quarterly dividend is paid in May, August, November and February, out of income and/or capital, equivalent to 1.25% of US dollar NAV at the end of each calendar quarter (previously semi-annual dividends were paid based on the fund’s level of income). The ability to pay dividends out of capital ensures that the managers are not forced to seek a higher portfolio yield, which may detract from capital growth. The declared FY19 dividend of 34.89c per share is 48.2% higher year-on-year, but FY18 was a transition year with just three, rather than four, interim dividends paid. Based on its current share price, BRLA offers a 6.0% dividend yield.

There are just two funds in the AIC Latin America sector, of which BRLA is the largest (the companies are not directly comparable as c 40% of Aberdeen Latin American Income Fund’s portfolio is invested in government bonds). BRLA’s NAV total returns rank first over three and five years, while lagging over the last 12 months. It is trading on a narrower discount, has a more competitive ongoing charge and is currently ungeared, unlike its peer. BRLA’s dividend yield of 5.7% is the highest of the two funds.

In Exhibit 10, we also include a selection of open-ended funds that invest in Latin America, to enable a broader comparison. BRLA’s NAV total returns are above the average of the open-ended funds over three, five and 10 years, while lagging over the last year.

There are five directors on BRLA’s board, all of whom are non-executive and independent of the manager. The chairman is Carolan Dobson (appointed on 1 January 2016, chair since 2 March 2017). Mahrukh Doctor was appointed on 17 November 2009, Nigel Webber on 1 April 2017, and Craig Cleland on 1 January 2019.

The newest director is Laurie Meister, who joined the board on 1 February 2020. She is also a member of BRLA’s audit, nomination, management engagement and remuneration committees. Meister has more than 30 years of experience working in financial markets, the majority of which were in Latin American and other emerging markets, both in New York and London. Her employers included Deutsche Bank, J.P. Morgan Chase and Robert Fleming. Meister was the senior broker advising the BRLA board when the company listed on the London Stock Exchange in July 1990, nearly 30 years ago.