Latin America has un-dergone a dramatic turnaround in the past few years, thanks to stronger global economies and rapid macroeco-nomic improvements in the region. With high demand for South America’s resources, a general improvement in fiscal budgets and stronger currencies, the continent’s stock markets have risen successively higher since the fall of 2002.

But Scott Piper, co-manager of the $255.4-million TD Latin American Growth Fund offered by Toronto-based TD Asset Management Inc. , argues that it’s not as simple as taking a top-down view. Capitalizing on the region requires a judicious mix of a macro perspective combined with bottom-up stock-picking.

“[The economies] are interactive and one tends to complement the other,” says Piper, executive director of Latin American funds for Morgan Stanley Investment Management Inc. in New York. He shares fund-management duties with Ana Cristina Piedrahita, executive director with Morgan Stanley in Athens, Greece. The pair assumed the Latin American fund portfolio in December 2002.

The fund is split mainly between Brazil (60%) and Mexico (31%). “In Mexico, there is a more stable economic outlook, given its proximity to the U.S.,” Piper says. “A lot of the economic convergence, in terms of interest rates and inflation, has already happened there. You’re not seeing wide degrees of economic volatility in Mexico. So, the weighting is driven more by bottom-up stock opportunities.”

Brazil is also benefiting from economic convergence. Its short-term interest rates are high, says Piper, “But they are falling to more normalized levels, particularly as inflation [which is around 4%] has fallen. Economic growth is rebounding at almost 5%, which is quite strong for Brazil relative to historical rates.”

As a result, the fund’s portfolio weightings are driven by a blend of top-down factors and individual stock picks.

In contrast, Chile, which is the most advanced economy in Latin America, holds few interesting stock-picking opportunities for the fund. As a result, the Chilean weighting is less than 2%.

“We see Mexico and Brazil going to where Chile is today,” Piper says, “with the larger opportunities in those two countries.”

This approach is delivering impressive results. The fund returned 42.4% for the 12 months ended Oct. 31, compared with 4.3% for the median fund in the miscellaneous fund category. For the three-year period ended Oct. 31, the TD fund delivered an average annual compound return of 44.6% vs an 8.2% for the median fund; for five years, the TD fund returned 36.6% a year vs 8.1% for the median. Over 10 years, the TD fund had an average annual return of 14.4%, vs 4.8% for the median. The TD fund has a five-star rating from Globefund, but Morningstar Canada has not rated it.

Another distinguishing feature is its high concentration — 35 to 40 stocks — of well-known names. “It’s part of our belief system to take larger bets,” says Piper. The top 10 positions include Companhia Vale do Rio Doce, at 10%; America Movil, at 9.2%; Petroleo Brasiliero SA, at 5.8%; and Grupo Televisa SA, at 4.6%.

SECULAR TRENDS

Piper and Piedrahita favour stocks benefiting from secular growth trends within the region. “We’re looking for areas with large pent-up demand and certain dynamics in place that will allow the company to grow its earnings over a long period, above and beyond the market,” says Piper, adding that those stocks are found in the consumer staples and discretionary, home-building, infrastructure and financial services sectors.

In some ways, Piper notes, Latin America is where the U.S. was 20 years ago. As was the case with the U.S., Latin America’s inflation is falling and growth is accelerating as interest rates drop. “Economic stability is higher, creating an incentive for investment spending,” he says. “But you’re not seeing upward pressure on inflation because productivity is rising. This is all happening at a time when the consumer is flush with cash and the banks are willing to lend.

“This is what we saw in the U.S. two decades ago,” he continues, “and what was needed for a multi-year consumer-related boom.”

One large holding that reflects growing consumer spending is Wal-Mart de Mexico SA, a subsidiary of Wal-Mart Stores Inc. “There is a lot of pent-up demand in Mexico,” says Piper, “given that real wages and employment are rising and inflation has moderated.”

Wal-Mex, as it’s known, is stealing market share from “mom and pop” retail outlets and larger retailers because of its greater efficiency, distribution systems and lower prices. “It’s expanding aggressively,” Piper says. “We think it’s a multi-year trend. It’s a steady 20% grower for the next few years.”

@page_break@Acquired by the TD fund almost five years ago, Wal-Mex shares recently traded at 40.5 pesos a share, down from 44 pesos at the beginning of the year. Piper has no stated target for the stock, but notes it is trading at around 20 times 2008 earnings. That multiple is deserved, he says: “As long as it keeps growing and improving profitability.”

Another favourite is Uniao de Bancos Brasilieros SA, known as Unibanco. Loan growth is expanding at about 28% a year in Brazil, says Piper, and has largely paid for establishing Unibanco’s branch networks. “[Unibanco] can grow at this rate without spending a lot of money. Costs are only growing at 5%-7% a year, which allows greater profitability,” he says. “Because credit penetration is low but growing quickly, it is also expanding fee-based services.” Unibanco earnings are growing by about 20% a year.

Consolidation will probably take place in the Brazilian banking sector, as foreign players want part of the action. Piper believes this will occur next year, once Brazil’s debt is rated “investment-grade”: “We have a lot of faith in management, and it is one reason we have a large weighting [in Unibanco].”

Bought three years ago, Unibanco stock was recently trading at US$142.80 a share on the New York Stock Exchange, up about 70% year-to-date. Piper is reluctant to offer price targets, as many companies’ profiles are subject to change.

A native of Miami, Piper has been a Latin American specialist for most of his career. After graduating in 1990 from Tulane University with a bachelor’s degree in international relations, he worked as an assistant branch manager at First Virginia Bank in the Washington, D.C., area. Piper’s interest in Latin America was inspired by his grandfather, a banker who was involved in finance in Brazil. That led to Piper’s enrolment at Instituto de Estudios Superiores de la Empresa — the IESE business school — in Barcelona.

After earning his MBA in 1995, Piper joined Deltec Asset Management LLC, a New York-based institutional investor that specializes in Latin America, and worked his way up to portfolio manager. Seven years later, he was hired by Morgan Stanley.

Piedrahita is a 12-year industry veteran who has worked at Fidelity Investments, HSBC Asset Management Ltd. and Baring Asset Management Ltd. She has a bachelor’s degree in economics and political science from Brown University and an MBA from the Massachusetts Institute of Technology’s Sloan School of Management. About a year ago, she moved to Athens when her husband was transferred there.

“Rather than disrupt the team and the process,” says Piper, “Morgan Stanley was willing to go the extra mile to keep it in place.” He adds that he and Piedrahita are in frequent contact and both visit Latin America several times a year.

Looking back, Piper believes demand for Latin America’s resources has been a key factor in allowing local governments to reduce their debt loads significantly: “When you combine that with good fiscal responsibility, you have a region with account surpluses. The overall economic profile is much more stable — and that’s allowed the risk premium to come down.”

Rising investment, growing consumption and strong earnings growth have been driving stock markets. At the same time, new companies are raising capital and reinvesting it: “It’s a virtuous circle.”

Piper admits there is a risk that the global economic cycle will slow or China’s growth rate will decelerate significantly. “But the largest risks are outside Latin America,” he says. “It is not that vulnerable anymore.” He expects the TD fund’s outsized performance numbers will moderate, but believes the outlook is robust.

Despite the TD fund’s stellar performance, analysts are cautious about recommending it. While the fund has benefited from strong economic growth and corporate fundamentals, Ranga Chand, an analyst and president of Chand Carmichael & Co. Ltd. in Ottawa, says advisors have to look closely at the fund’s somewhat volatile history and be prepared to wait for results: “If you follow a buy-and-hold strategy, you have to hold the fund for a minimum of 10 years.”

Analysing performance since the fund’s inception in November 1994, Chand found that over 35 rolling 10-year periods, the range of average annual compound returns was huge — from a low of 2.4% to a high of 13.9%, with an average of 10.8%. The range was even greater when Chand examined five-year rolling returns — from 37.5% annualized for the best five years to a 9.7% loss for the worst five years.

“Given the volatility, the best advice is putting in about 5% — but in an aggressive portfolio,” says Chand. “You need to tell your client, ‘This is a long-term investment with a 10-year holding period’.”

Dan Hallett, president of Dan Hallett & Associates Inc. in Windsor, Ont., is more cautious: “I don’t recommend any Latin American funds. They are not suitable for the vast majority of clients.”

Hallett prefers emerging markets funds, and suggests they provide adequate exposure to Latin American stocks. IE