BlackRock Latin American Investment Trust — Optimistic outlook for Latin American equities

Over the last 10 years, Latin American equities have failed to keep up with the performance of world equities (Exhibit 2, left-hand side). Along with economic volatility there has been political upheaval in the region. While this may continue into the future, one may argue that these issues are already reflected in share valuations. Looking at Datastream indices in the right-hand chart, on a relative forward P/E basis, Latin American equities are trading at a 6.7% discount to global equities, which is wider than the 4.4% average of the last 10 years. It is also worth noting that over the last decade, there have been periods where Latin American equities have traded at a premium to world equities. For investors seeking exposure to the region, a well-established, relatively diversified fund, with a disciplined investment approach, may hold some appeal.

BRLA has been managed by BlackRock since March 2006. The trust is listed on the Main Market of the London Stock Exchange. Its share price is quoted in sterling and its financial statements are reported in US dollars, while its NAV is quoted in both currencies. BRLA’s objective is to generate long-term capital growth and an attractive total return from a diversified portfolio of Latin American equities. Manager Will Landers invests in line with a set of broad investment limits:

Derivatives can be used for efficient portfolio management, but no more than 20% of the portfolio may be under option at any given time. Currency exposure is unhedged. Gearing of up to 25% of NAV is permitted; at end-January 2018 net gearing was 6.6%.

Landers is optimistic on the outlook for Latin American equities in 2018, noting that consensus earnings growth for 2018 is currently c 11% and the forward P/E multiple is c 14x. In Brazil, which is by far the largest country in the benchmark (c 60%), the manager says the central bank has won its battle with inflation. The current rate is below 3%, which is the lowest in c 20 years. Landers says that Brazilian interest rates have come down by more than 50%; the Selic overnight rate is now 6.90% compared with 14.15% in Q416. He expects a further one or two cuts to bring the rate down to 6.50% and says that lower interest rates have been a big boost to the economic recovery. Banks are now more willing to lend to individuals and small- and medium-sized companies. Higher commodity prices are also very beneficial to the Brazilian economy.

The manager highlights reforms in Brazil, such as those in the labour market, which are helping to reduce the cost of doing business. There are uncertainties within the country, such as the tenure of President Temer, who is under investigation for passive corruption. However, he looks set to serve the remainder of his term in office following a recent congressional vote, which increases the likelihood of expected pension reforms being announced. This is most likely after the October 2018 presidential election. Landers believes that whoever the successful candidate is, they will be able to continue with the positive programme of reforms that Temer started in 2016.

In terms of economic improvement, the manager notes the decline in unemployment in Brazil, and says that retail sales are recovering across the board. Traffic on toll roads is increasing, both for commercial and leisure purposes, and airport traffic is also picking up. Landers says that Brazil has experienced a very long recession, but is now in recovery, which he describes as “slow and sure”.

The manager now has a more cautious view on Mexico due to the ongoing NAFTA negotiations. He notes that the value of the Mexican peso tends to be a barometer of how negotiations are progressing. However, he says that a final deal is a long way off, and there is a lot at stake for President Trump and US exporters if the US were to pull out of the trade agreement.

Landers believes that investors should not overlook Latin American equities. While emerging market equity performance in 2017 was led by Asian technology companies, he says that 2018 could be the time for laggard markets to catch up if investors have continued confidence in a cyclical recovery in emerging market economies. He expects virtually all economies in Latin America to have faster economic growth in 2018 versus 2017 and, in general, inflation remains under control. The manager is expecting growth in Mexico in 2018 to be broadly in line with 2017, driven by industrial multinational companies. However, he is comfortable with the growth profiles of the Mexican companies in BRLA’s portfolio, such as bank Grupo Financiero Banorte, beverage company Femsa and telecom operator America Movil. Landers says that there have been meaningful changes in Latin American company earnings estimates over the last six months, some of which have been due to currency moves. He believes that for the first time in quite a while, earnings estimates look realistic and there is potential for upside revisions, especially in Brazil.

Landers takes into account the macro environment and undertakes thorough fundamental analysis to construct a diversified portfolio of Latin American equities, aiming to generate long-term outperformance with below-average volatility. He seeks companies with quality management teams with good long-term track records and a positive corporate governance history, including a regard for minority shareholders. Fundamental analysis includes an assessment of a company’s growth and cash flow generation potential and the strength of its balance sheet. The manager seeks companies that are trading at a discount to their assessed underlying value. Landers is able to draw on the broad resources at BlackRock, including the Latin American investment team and a proprietary research network. BRLA invests across the market cap spectrum, although c 75% of the portfolio is invested in companies with a market cap above $8bn. It typically comprises 50-75 holdings and turnover is generally 40-60% pa.

Changes in geographic exposure over the last 12 months to end-January 2018 have been modest, with a 1.5pp increase in Mexico and a 2.1pp decrease in Peru (Exhibit 3).

Changes in sector exposure over the period are more significant, including a 9.0pp higher weighting in consumer discretionary, and a 6.3pp lower weighting in consumer staples. Holdings in the consumer discretionary sector include Brazilian companies Magazine Luiza (multi-channel retail), Lojas Renner (apparel) and Lojas Americana (department stores).

At end-January 2018, BRLA’s second largest position was Vale, the world’s largest producer of iron ore and nickel. The company generated a total return of c 65% in 2017, which was more than double the total return of the broader Brazilian stock market. The manager is positive on the company’s new CEO (since May 2017), who has increased the focus on core operations and reduced Vale’s level of debt. Landers believes there is a variety of measures that the company can take to increase margins and reduce the effects of industry volatility. Vale is also an example of a company that is improving its corporate governance record, which includes moving from two share classes to a single one. In recognition of the improvement, the company is now listed on Novo Mercado, which is a distinct level on the Brazilian stock exchange reserved for companies with a distinguished standard in corporate governance and shareholder protection.

As shown in Exhibit 5 (right-hand side), over the last 12 months, BRLA’s NAV and share price total returns of 18.9% and 21.4% respectively are comfortably ahead of the benchmark’s 15.5% total return. The manager says that there have been multiple contributors to the outperformance, including exposure to Argentina, which is not represented in the benchmark, and positive stock selection in Brazil such as rail logistics operator Rumo Logistica Operadora Multimodal and mining company Vale. The improvement in relative investment performance ensured that the biennial 14.99% tender offer was not triggered (see Discount section below).

BRLA’s relative returns are shown in Exhibit 6. Due to the stronger recent relative performance, the trust’s NAV total return is now ahead of the benchmark over one, three and five years, while broadly in line over 10 years.

As shown in Exhibit 8, BRLA’s share price discount to cum-income NAV has been in a relatively consistent range over the last three years of between c 8% and c 16%. The current 14.6% discount is towards the wider end of the 8.0% to 17.6% range of the last 12 months. It compares to the averages of the last one, three, five and 10 years of 13.2%, 12.8, 11.8% and 8.0% respectively.

In order to help manage a discount or premium, the board has the authority, renewed annually, to repurchase up to 14.99% of its ordinary shares and allot up to 5% of its issued share capital. Before mid-2013, there was a policy of twice-yearly 5% tender offers. On 23 August 2013, a new discount policy was introduced that the board believes is in the better interests of its long-term shareholders. From the 2016 continuation vote onwards, if BRLA has underperformed the benchmark’s total return (in $ terms) by more than 1% pa over the previous two financial years and the share price discount to cum-income NAV has averaged more than 5% over the same two-year period, a 24.99% tender offer will be launched. The tender price will be the cum-income NAV less 2%, to cover the cost of the tender. Over the two-year period to 31 December 2017, BRLA underperformed the benchmark by 1.5pp, which was above the performance threshold; therefore the biennial tender offer will not be implemented.

BRLA is a conventional investment trust with one class of share in issue; there are currently 39.4m ordinary shares outstanding. The trust has an overdraft facility for up to $40m with Bank of New York Mellon at an annual rate of Libor plus 1%. Gearing of up to 25% of net assets is permitted; at end-January 2018, net gearing was 6.6%, which is broadly in the middle of the historical range of a modest net cash position to c 12% geared. The trust is subject to a two-yearly continuation vote, with the next opportunity at the May 2018 AGM.

Effective since 1 January 2017, BlackRock is paid an annual management fee of 0.80% of net assets, which is charged 75% to capital and 25% to income; the prior fee was 0.85% of net assets. Historically, a performance fee was payable to reward outperformance versus the index. This has now been removed. In 2016, BRLA’s ongoing charge was 1.2%, 10bp higher than in 2015.

BRLA pays dividends twice a year, in October and May. In 2015, rather than continuing to pay dividends out of capital, the board decided to reduce the dividend to a level more in line with earnings. During 2015, an interim dividend of 15c was paid, which was in line with the prior year, but the final dividend was lowered from 15c to 6c. In 2016, the total dividend of 15c was 29% lower than in 2015. In H117, a 6c dividend was declared, which was in line with the prior year and compares to a 7.5c revenue return over the period. Based on its current share price, BRLA has a dividend yield of 2.4%.

BRLA is one of just two trusts classified in the AIC Latin America sector. In Exhibit 9 we also compare the trust to two US-listed funds invested in the region, along with a selection of open-ended funds. BRLA’s NAV total return is ahead of the closed-end fund average over one, three and five years, ranking first, second and first out of four funds respectively, while lagging the average of three funds over 10 years. The trust’s ongoing charge is the lowest of the closed-end funds, it has the second highest level of gearing and the second highest dividend yield, which is broadly in line with the average.

Comparing BRLA with the open-ended funds, its NAV total returns are above average over all periods shown. Its fees and dividend yield are also competitive versus the open-ended funds.

There are five directors on BRLA’s board, all of whom are non-executive and independent of the manager. Chairman Carolan Dobson was appointed in 2016 and assumed her current role following the retirement of Peter Burnell in March 2017. Antonio Monteiro de Castro was appointed in 2007; he is the senior independent director and chairman of the audit committee. The other three directors and their year of appointment are Laurence Whitehead (2003), Mahrukh Doctor (2009) and Nigel Webber (2017).