With improved governance, investment has a real future
While global investors debate the resilience of emerging markets in the wake of the deepening global market turmoil, many long-only equity funds remain resolutely overweight Latin assets, spurred on by the region’s growth prospects.
Investors are beefing up their exposure to domestic stocks despite soaring valuations, banking on strong corporate earnings growth against an increasingly stable macroeconomic backdrop.
“Emerging markets are at relatively early stages of development, and financial services penetration is low. This means that if you go long, there is great money to be made, so forget about US subprime for now,” says Will Landers, senior portfolio manager at BlackRock.
Local exposure to domestic equities is rising. In January, Mexican local pension funds (Afores) increased their holdings of local stocks by 2.2 billion pesos, a monthly increase of 5.4%, even as the country’s equity index fell by 2.5%.
Governance
Broader change in the region’s equity markets partly hinges on radically improving corporate governance, a process which has so far helped draw traditionally cautious local pension funds into domestic equities.
One of the clearest examples of this trend is the development of Novo Mercada, a Brazilian exchange which allows local firms to adopt international governance standards upon listing. Aside from offering greater transparency, the exchange promotes a one vote per share policy to protect minority shareholders.
The initiative – with its advances in market oversight and regulation – has revolutionized Brazil’s capital markets and boosted investment flows to equities, according to Cristiana Pereira, an adviser to Bovespa.
“We believe [Novo Mercada] was the major turning point,” says Pereira. “Once we had the change in market infrastructure and good economic scenario from 2004 onwards, the stock markets took off.”
The hope is that the proliferation of independent management boards coupled with relatively low leverage among Latin firms will help spell an end to cycles of boom and bust in the region – a fact which should allow investors to position themselves long term.
“Improved corporate governance in the wider economy and investment-grade behaviour from the bottom up means the region’s equity market can only continue its upward momentum in the medium and long term,” says Marcelo Salomon, chief economist at Unibanco.
Domestic bid
Ultimately, it is domestic buyers who will ensure that the region’s equity markets are no longer held hostage to the wavering risk appetite of foreign investors. “We need to develop an investment culture that encourages retail investors to go into equities rather than just concentrating on bank deposits and alternative investments,” says Evandro Pereira, head of LatAm equity capital markets at UBS.
Retail investors make up only 25% of Brazil’s market, the highest level of retail participation in the region. But with any luck, a pick-up in domestic investment will provide the liquidity for smaller firms to list – and in so doing, ensure Latin America’s equity boom can reach portions of Latin society. —S.V.