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Southern Charm: Interview with Heiner Skaliks of Strategic Latin America

By Jim Fink on July 11, 2011

Brazil has become the political and economic leader in Latin America.

Elliott Gue, Personal Finance

Four months ago I wrote an article entitled Brazil is the Best Emerging Market. So I was happy to see my colleague and friend Ben Shepherd, associate editor of Personal Finance, discuss the topic of Latin American investing more fully in one of his fund manager interviews. I found the interview very enlightening and I’m sure you will too. — Jim Fink

Political turmoil continues in the Middle East. A debt crisis brews in Europe. China and other emerging markets battle inflation. Amid the uncertainty, assets have begun to flow from emerging markets into the US. But Heiner Skaliks, manager of Strategic Latin America (SLATX), notes that Latin American countries have emerged from the turbulent decades of the 1980s and 1990s stronger than ever. These countries enjoy robust economic growth and relatively low levels of inflation. For sound investments in stable developing markets, investors need only look south.

Ben Shepherd: How does Latin America compare to the rest of the world as an investment destination?

Heiner Skaliks: Latin America used to be in the spotlight for all the wrong reasons, especially in the 1980s and 1990s when the region experienced social and economic turmoil as well as hyperinflation. In the 1980s Bolivia had an inflation rate of 25,000 percent. If you didn’t spend your money immediately, the goods you needed at the store would have doubled in price.

In the past Latin America was plagued by three ghosts. The first was political instability, but the region has come a long way on that front. Last year, four regional presidential elections resulted in smooth transition of power; these democracies have matured significantly.

Weak currencies were another historical challenge for Latin America. Local currencies reflect the strength of these nations’ real economy. The US dollar, the German deutschmark and the British pound were king in the region because the local currencies were so weak. You could purchase just about anything with foreign currency in those days. In the 1980s and 1990s, Latin American economies were in a developmental stage. Consequently their currencies were weak and volatile, limiting the regions growth potential.

Inflation was the final ghost. High demand combined with low economic output drove prices higher. The situation is far different now. Few countries in Latin America—except Brazil to a certain extent—are experiencing double-digit inflation. The threat of the three ghosts diminishes as Latin America achieves a higher level of political, social and economic maturity. Other regions of the world are just beginning to undergo similar changes. Hopefully this transition won’t involve bloodshed and will create better living conditions for the people who live there.

Additionally, in the 1980s and 1990s, Latin America’s population and internal demand was less than 20 percent of what it is today. The region’s population currently stands at about 600 million, which is twice the size of the US population. This surge in population has created a robust internal market. We’ve witnessed a significant south-south trade of goods and services—for example Brazil exporting to Bolivia or Columbia exporting to Peru. That’s a far cry from previous decades when the largest buyers of Latin American goods were the US, Europe and Japan

The region is also blessed with natural resources that are now packaged with a higher value-added proposition. This is the case for both finished goods and the raw commodities that are essential inputs to global economic growth.

Furthermore, a rising middle class has become an increasingly important target market for goods and services. The consumer market is growing at an annual rate of 4 to 5 percent. Strengthening currencies also have boosted the middle class’ spending power. More Latin American goods and services are consumed within the region—a positive development.

Ben: Is it still fair to say that resources are largely responsible for the region’s wealth?

Heiner Skaliks: Resources are one of the main drivers of the region’s wealth. But tourism and exports of local services are also contributing to economic growth. There’s also manufacturing. US and European companies are beginning to grow wary of China as labor costs rise. Increasingly, they’re looking to Central America for labor. Technology and pharmaceutical companies, in particular, are beginning to focus on Brazil and Chile. Although the process is in an early stage, it’s reducing the region’s dependence on resources for economic growth.

Ben: Given that resources still play a critical role to the region’s economy, will slowing economic growth and inflation in countries such as China crimp Latin America’s growth?

Heiner Skaliks: Capital always seeks the highest potential return. At the end of last year, we saw an outflow of funds from Latin America back to developed economies. Investors bet on a speedier recovery in the US and a more promising outlook in Europe. In the first quarter of 2011, capital returned to Latin America because the region provides investors with promising growth characteristics and returns.

Meanwhile, China is trying to slow down its economic growth by draining cash from its financial system through interest rate hikes and higher bank reserve requirements. Given that the economic recovery in the US will likely be slower than what was previously expected, money will continue to flow into Latin America.

Ben: What Latin American countries would you suggest investors consider?

Heiner Skaliks: Peru is a good option. The country’s economy grew by 9 percent in the first quarter amid manageable inflation. Peru has a strong monetary policy and its currency has been more stable than those of other countries in the region. Peru is also rich in natural resources.

We also like Brazil because of its high demand for housing and infrastructure. Brazil will host the 2014 World Cup and the 2016 Olympic Games in Rio de Janeiro—the world’s two largest sporting events. These are expected to draw massive flows of goods and services to Brazil, and the country is beginning to prepare for these events.

But Brazil is overvalued. A colleague of mine attended a conference there in mid-May and paid USD12 for a croissant and a cup of coffee at a local corner shop. That’s more expensive than what you’d find in New York or Tokyo. Brazil has a population of about 180 million people, making it the largest country in South America. This means that there’s still significant potential for growth, but it isn’t an across-the-board opportunity.

Investors must be selective when deciding which industries to invest in. We like banking services because a large portion of the population still lacks access to financial services. We also are bullish on consumer goods and anything related to food or retail services.

We’re also looking at Mexico whose economy directly reflects the pace of the US recovery. If the US economy improves at a faster rate than predicted, this growth will spill over into Mexico.

Ben: What are your favorite picks in the region?

Heiner Skaliks: Creditcorp (NYSE: BAP) is Peru’s largest financial holding company and owns the largest commercial bank in the country. The firm also has operations in Bolivia and we are confident in its management. The company’s earnings grew 46 percent year over year in the first quarter. But there’s more room for growth because many Peruvians continue to lack access to banking services.

On the fixed-income side, we own JBS SA 10.5% due 8/4/2016 (ISIN: USP59695AC39). JBS (Brazil: JBSS3, OTC: JBSAY) became the world’s largest meat processor after it bought US-based Swift and Pilgrim’s Pride. Those acquisitions demonstrate the degree to which globalization has benefited Brazilian companies.

Staying with fixed income, we also like Financiera Independencia SA de CV 10% due 3/30/2015 (ISIN: USP4173SAB09). Financiera Independencia is one of Mexico’s largest microfinance institutions and has tremendous growth potential arising from a low penetration rate for financial services in the country. 

Ben: Are there any countries or sectors that investors should avoid?

Heiner Skaliks: We don’t invest in Bolivia because the fixed-income rates in US dollar-terms are lower than what you can find in the US. The same is true in Ecuador and Venezuela, where there’s simply too much risk for too little reward.

Ben: What’s your best piece of advice for investors?

Heiner Skaliks: Diversification is key. I suggest that investors allocate 10 to 15 percent of their portfolio to Latin America. Ideally those investments would include both equity and fixed-income exposure.

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