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Schroder ISF* Latin American
Monthly Fund Update
Covering May 2017
Overview
Latin American equities finished in negative territory in May, owing to a decline in the Brazilian market. Ongoing
weakness in commodity prices was also a headwind. The MSCI Latin America 10/40 index posted a negative return to
underperform the MSCI Emerging Markets index. The fund marginally underperformed due to negative country allocation.
The market and the drivers of fund performance
Global equities recorded a positive return in May as ongoing recovery in global activity supported risk appetite. In the US, political
risk increased following President Trump’s dismissal of the FBI director. This weighed on the outlook for growth, amid concern that
reforms may be delayed, and the US dollar weakened. In Europe, macroeconomic data showed signs of ongoing recovery and a flash
eurozone composite PMI index reached a 73-month high. Latin American markets finished in negative territory, owing to a decline in
the Brazilian market. Ongoing weakness in commodity prices was also a headwind. The MSCI Latin America 10/40 index posted a
negative return to underperform the MSCI Emerging Markets index.
Brazilian equities lost value in the wake of corruption allegations against President Temer. This development increases the risk that
the key social security reforms are not passed before general elections in 2018. Macroeconomic data remained relatively subdued,
with retail sales down 4% year-on-year (YoY). A manufacturing Purchasing Managers’ Index (PMI) reading showed a small increase in
activity at 50.1, while industrial production growth turned positive, rising 1.1% YoY. Inflation maintained a downward trend and the
central bank lowered its headline interest rate by 1% to 10.25%. However, this was less than anticipated at the start of the month,
before news of the allegations against President Temer broke.
Chile generated a marginally positive return. On the data front, first quarter GDP growth was 0.1% YoY, the slowest pace since 2009.
The key drag was construction but ex-mining, economic activity showed some improvement, notably domestic demand. Recent
growth indicators have remained weak, with industrial production contracting 4.2% YoY in April. Against this backdrop the central
bank lowered its key monetary policy rate by 25bps to 2.5%, but appeared to drop its easing bias in the accompanying minutes.
Mexico registered a small gain. Momentum in the domestic economy remained relatively firm with retail sales rising 9.1% in April.
Meanwhile low unemployment persisted at 3.5%. By contrast, industrial production was weaker, declining 0.2% in March, and
Manufacturing PMI ticked up to 47.6, but remained in contraction territory. Inflation increased to 5.8% YoY in April and the central
bank unexpectedly increased its headline interest rate by 25bps to 6.75%.
Colombia posted a strong gain, primarily due to a rally from Bancolombia. However, GDP growth decelerated to 1.1% in the first
quarter, with investment, exports and government spending all weaker. Higher frequency data suggests weakness in consumption
with retail sales falling 2% in March. Inflation declined to 4.7% YoY in April and the central bank loosened monetary policy again,
cutting its headline rate by 25bps to 6.25%.
Peru was the best performing market, supported by a strong gain from large index stock Credicorp. First quarter GDP growth slowed
to 2.1% year-on-year (YoY) and expectations for full year growth have been revised down to 3.3%. This reflects the impact of floods in
Northern Peru, as well as an ongoing corruption scandal. The central bank unexpectedly cut interest rates by 25bps to 4% in an effort
to provide support, with inflation falling to 3.7% in April. Meanwhile the current account deficit showed significant improvement in
the first quarter, narrowing to 1.9% from 5.5% 12-months ago.
The fund marginally underperformed due to negative country allocation. Being underweight to Peru, overweight to Brazil and
underweight to Chile all had a small negative effect. Stock selection had a comparatively neutral impact on relative performance.
Selection in Mexico was positive, in particular the off-index holdings in cement producer Moctezuma and steel manufacturer
Ternium. Moctezuma benefited from ongoing strength in cement demand, particularly in the low income self-construct segment.
The company has increased capacity in the last 12-months, is highly cash generative and with little debt is able to pay out an
attractive dividend. Meanwhile steel producer Ternium gained as spot prices ticked higher. Mexican steel prices are linked to those in
the US, where speculation over protectionist measures has pushed prices higher. Moreover, domestic Mexican demand has been
supported by demand from car manufacturers in particular. Being overweight to FEMSA was also positive, given a firm domestic
outlook for retailers, and as other business units, namely Coca-Cola FEMSA and Heineken, continue to perform well. In contrast, stock
*Schroder International Selection Fund is referred
to as Schroder ISF throughout this document.
Schroder ISF Latin American
Covering May 2017
1
selection in Brazil was negative. Our overweight to banks was the largest headwind; these stocks lost value given increased
uncertainty over economic recovery in light of the corruption scandal surrounding the president.
The market outlook and portfolio strategy
Year-to-date Latin American equities have benefited from an improved external environment. The synchronised pickup in global
growth, US dollar weakness and a reduction in US trade policy risk have all been supportive. A reversal in commodity price strength
over recent months has been a headwind however.
In Brazil, the political and reform outlook has been negatively impacted by the corruption scandal surrounding President Temer. As a
result the likelihood of key structural reforms, notably pension reform, passing before 2018 general elections has decreased.
However, the positive cyclical outlook remains intact. Inflation continues to fall and further rate cuts are expected, agricultural
exports have picked up and the current account deficit has narrowed. We still expect a recovery in Brazilian growth this year, albeit at
very modest levels. In Peru, GDP growth continues to expand at a decent rate. However, the majority of this strength stems from past
investment in mining, while the domestic economy is slowing. The government’s fiscal stimulus has potential to boost domestic
demand but this has been delayed, given institutional weakness, corruption allegations and the impact of recent floods. In the
absence of stimulus, a reacceleration in growth may be dependent on private investment, which remains subdued. In Chile, the main
focus is on November’s presidential elections. Former president and centre-right candidate Sebastian Piñera leads opinion polls.
These elections have potential to be a positive catalyst for investment and confidence but in the near-term growth is likely to remain
subdued. In Colombia, the outlook is more stable with the twin deficits both showing some improvement. Inflation is falling and the
central bank has started an easing cycle. For Mexico, concerns over the potential cancellation of NAFTA have receded. However,
uncertainty stemming from the Trump administration’s policies, and the potential impact on exports, continues to be a risk. Inflation
is rising following peso weakness and fuel price deregulation. On the other hand, the outlook for 2018 presidential elections is now
more positive. The ruling PRI’s victory in June’s State of Mexico election, and a coalition between the PRD and PAN, materially
weakens the chances of left wing party, Morena, being elected.
The key change to our country allocation in early June was to moderate the magnitude of the Brazil overweight. Political risk has
increased, and is expected to weigh on the pace of reforms. We reinvested the funds in Argentina where we have identified a strong
stock opportunity. Overall the fund remains positioned as follows:
We stay overweight Brazil where political uncertainty has increased but the economy appears to be bottoming and expectations are
for further monetary policy loosening. We also hold an off-benchmark allocation in Argentina, given strong stock opportunities.
Elsewhere, we are underweight Peru where the economy is slowing and there is some commodity price risk. Colombia is also held
underweight. Valuations are reasonable and the twin deficits are gradually improving, but growth is still slowing. In Chile, there is
potential for policy improvement but economic growth remains weak and we hold an underweight position. We remain underweight
to Mexico. Although we have identified some compelling bottom-up ideas, valuations are expensive and there is downside risk to
earnings.
Important Information: This document does not constitute an offer to anyone, or a solicitation by anyone, to subscribe for shares of Schroder
International Selection Fund (the “Company”). Nothing in this document should be construed as advice and is therefore not a recommendation to buy
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Schroder ISF Latin American
Covering May 2017
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