Banks and retailers have joined commodity giants in the spotlight, but have they come too far too fast?
Brazil looms large in many emerging-markets portfolios. The average emerging-markets stock fund had a 16% stake in Brazilian equities as of Aug. 4, 2010, making it the largest country weighting. (The typical Latin America fund devoted roughly 71% of assets to the country.) In some cases, this exposure reflects the popularity of Brazil's commodity giants: energy firm Petroleo Brasileiro
But there's much more to Brazil than its diverse natural resources. The country's middle class has flourished in recent years thanks to low interest rates and easier access to credit. Growing income levels could set the stage for more robust retail sales, industrial spending, and housing demand. Reflecting these trends, the MSCI Brazil Index, though still heavy in the energy and materials sectors, has shifted away from those areas more toward financial services and consumer-related industries in recent years. And exposure to telecom firms fell to roughly one fourth of its former weight.
Domestic-oriented stocks were big drivers in Brazil's huge 128% rally in 2009. But the market has taken a breather in 2010: The index shed nearly 3% for the year to date through Aug. 4, 2010. While worries about a global economic slowdown has dinged commodity plays, domestically oriented stocks have also come under pressure given the risks of rising interest rates and a slowdown in foreign investment.
So, what's the outlook from here? Is the expansion of domestic-oriented sectors the sign of a new dawn for Brazil's market, or have Brazil's stocks become too popular for their own good? Not surprisingly, fund managers disagree on that important question.
Can the Carnivale Continue?
When you compare Brazil's investing climate with those of the other large developing countries, there is a lot to like. In addition to being a large, diverse economy, it's considered to be one of the more stable markets from a political standpoint. It also suffered less during the financial crisis of late 2007 through early 2009 and recovered much faster. And from a regional standpoint, its securities exchange operator, BM&FBovespa, boasts Latin America's most liquid stock market and has the most stringent listing requirements. (This promotes better behavior on the part of listing firms.)
In recent years, Brazil's banks have attracted many fund managers. Howard Appleby, who comanages foreign large-blend mutual fund Harbor International
Plays on the growing demand for infrastructure and housing have also been quite common. Will Landers of BlackRock Latin America
Meanwhile, T. Rowe Price Latin America's
Or Will These Stocks Get Kicked Capoeira Style?
Toward the end of last year, and even more recently, some managers have found the entire market too rich. For example, Ruchir Sharma of Morgan Stanley Institutional Emerging Markets
Earlier this year, Adam Kutas of Fidelity Latin America
Thomas White, who runs foreign large-value fund Thomas White International
Investors who want to target Brazil can choose among a handful of Latin America stock funds and Brazil-focused options in both the mutual fund and exchange-traded fund formats. But making such narrowly focused plays can backfire. Many investors will find they can get ample exposure to the country through diversified emerging-markets funds or even broad international funds. Lately, several prominent foreign funds have sported even exposure between Brazilian commodity- and consumer-linked businesses.
Keep in mind that Brazil's more diversified equity market won't spare it if commodity-oriented stocks are pummeled. And although the country's political climate has been stable in recent years, investors will be watching the October presidential election closely. Neither of the front-runners are expected to institute major policy changes, but it remains to be seen how the new president will handle fiscal policies geared to bring down real interest rates as well as social policies that can keep the country's middle class growing at a steady clip. The latter includes the overall trend in wage increases and reforms that will boost its citizens' savings rates.
Karin Anderson is a mutual fund analyst with Morningstar.