Can these niche funds build on their gains?

After the first round of Brazil's presidential election on Sunday 4 October, the country's Ibovespa stock market index jumped by 7.7%, its biggest one-day gain for more than six years.

The rally followed a better-than-expected result for Flávio Bolsonaro, the son of former president Jair Bolsonaro, who finished ahead of the incumbent president, Luiz Inácio Lula da Silva.

Neither candidate secured an outright majority, so the election will now go to a second round on 25 October.

Investors welcomed the prospect of a more business-friendly government, with expectations of tighter control over public spending and economic reforms helping to push Brazilian shares to record highs.

At Saltydog Investor, we keep a close eye on the performance of global stock market indices, as well as the Investment Association sectors and the individual funds within them.

Brazil's recent performance has not only caught our attention, but it has also prompted us to take another look at the wider Latin American region.

What's in a LatAm fund?

The Investment Association introduced the Latin America sector in 2021 for ‘funds which invest at least 80% of their assets in Latin American equities’.

The IA defines Latin America by reference to countries included in recognised indices and expects funds in the sector to be geographically diversified; single-country funds are classified in the Specialist sector.

The sector started the year well, gaining 14% in January, but has fallen back slightly since then. At the end of September, it was showing a year-to-date gain of 10.2%.

It only rose by 0.2% in September. However, October has got off to a much more encouraging start. As of Friday 9 October, the Latin America sector was the best performer, up 8.3% so far this month.

Although Brazil dominates many Latin American investment funds, it is by no means the only country worth considering.

Other exposures

The MSCI Emerging Markets Latin America Index covers five countries: Brazil, Mexico, Chile, Peru and Colombia.

However, it is worth noting that the economies of these countries are quite different.

Brazil is the largest economy in South America and has enormous natural resources, including oil, iron ore and agricultural commodities.

It also has a substantial domestic consumer market and a large financial services industry.

Mexico, meanwhile, is more closely integrated with the United States, with around 80% of its exported goods going north of the border.

This has encouraged companies to establish manufacturing operations in Mexico, particularly in the automotive, electronics and engineering industries.

Chile and Peru are both important mining economies, particularly when it comes to copper, while Colombia has significant oil and coal industries.

Argentina is another major South American economy, with substantial agricultural resources, oil and gas reserves, and lithium deposits.

Although Argentina is not currently included in the MSCI Emerging Markets Latin America Index, its economic developments remain relevant to the wider region.

What comes next

Looking beyond the individual countries, there are several reasons why Latin America might be of interest to investors.

Three of the big investment themes that we have been following this year are oil, gold and artificial intelligence. All three have implications for the region, although the effects are not necessarily the same in every country.

Oil prices have risen significantly this year, largely because of the conflict in the Middle East.

That has been good news for oil producers such as Brazil's Petrobras, which can benefit from higher selling prices. Colombia, Ecuador and Argentina also have significant oil industries.

However, higher energy prices increase transport and production costs across the region, adding to inflationary pressures and making it more difficult for central banks to reduce interest rates.

Gold has also attracted considerable attention this year.

Although prices have fallen back from their record highs, they remain historically elevated.

Gold mining is an important industry in several Latin American countries, including Peru, Mexico and Brazil.

Higher prices can significantly improve mining companies' profitability, although rising energy costs can offset some of the benefit.

As we have seen from the performance of specialist gold funds over recent months, this can also be a particularly volatile area of the market.

The third major theme is artificial intelligence. 

Latin America might not immediately spring to mind when thinking about the AI boom, but the region has an important role to play in supplying the materials and infrastructure needed to support it.

Chile and Peru are among the world's largest copper producers, and demand for copper is expected to grow as more data centres, electricity networks and other infrastructure are developed.

Brazil is also attracting investment in data centres, helped by its large domestic market and substantial renewable electricity generation.

China is another important part of the story.

It has become Brazil's largest trading partner, buying enormous quantities of iron ore, oil and agricultural products. Chile and Peru also export substantial amounts of copper and other minerals to China.

Strong demand from the Chinese economy can therefore provide a significant boost to Latin American businesses, but a slowdown could have the opposite effect.

The relationship with the United States is rather different, particularly for Mexico.

Since returning to the White House, Donald Trump has repeatedly threatened or introduced tariffs on Mexican goods, creating uncertainty for companies dependent on trade with the US.

The US-Mexico-Canada Agreement (USMCA) underwent its first joint review in July, but the US declined to extend it for another 16 years.

The existing agreement remains in force, although its longer-term future is uncertain, with further negotiations and annual reviews ahead.

Elsewhere, the US military intervention in Venezuela at the beginning of the year, which resulted in the capture of President Nicolás Maduro, demonstrated how quickly the political situation in the region can change.

Brazil finds itself in an interesting position. It has developed strong economic ties with China, while also maintaining important trading and diplomatic relationships with the United States.

The outcome of its presidential election could influence how those relationships develop, although its dependence on Chinese demand for commodities is unlikely to disappear.

For UK investors, gaining exposure to the region is relatively straightforward through exchange-traded funds and investment trusts.

The iShares MSCI Brazil ETF USD Dist GBP (LSE:IBZL) provides more direct exposure to the Brazilian stock market, while the BlackRock Latin American Ord (LSE:BRLA) trust invests across the wider region.

There are also actively managed open-ended Latin American funds, although the choice is relatively limited compared with more mainstream geographical sectors.

All three funds from the Latin America sector started the year strongly, but their performance became more volatile during the spring and summer.

The recent rally has given them another boost, with abrdn Latin American Equity I Acc (B4R0SD9) and CT Latin America Z Acc GBP (B8BQ6V5) now showing year-to-date gains of more than 25%. Liontrust Latin America C Acc GBP (B909HH5) has also performed well, although its gains have been more modest.

The recent jump in Brazil's stock market has certainly brought Latin America back into focus. However, the region's prospects depend on far more than one election result.

Commodity prices, demand from China, US trade policy and the continued investment in AI infrastructure could all have a significant influence on returns.

At Saltydog Investor, we will be watching to see whether the recent improvement in sentiment towards Brazil develops into a more sustained trend, and whether Latin American funds can build on the gains they have already made this year.

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