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Saturday, November 20, 2010

The Aberdeen Latin America Equity Fund

Profile

 | SATURDAY, NOVEMBER 20, 2010

São Paolo Style

Aberdeen Latin American Equity Fund manager Nick Robinson is making a big bet on Brazil and its booming consumer economy.

NICK ROBINSON WAS SWAMPED DURING his first visit to Latin America, in 1997. As a member of the Oxford crew rowing in a demonstration meet in the rain forest up the Amazon, Robinson found his shell taking on water from the wakes of old gunboats carrying local TV cameramen filming the race. His boat sank while the rival Brazilian rowers cruised to victory.
"This taught me in no uncertain terms how important it is to understand local customs and behavior whenever venturing into foreign places," explains Robinson. He's learned to navigate the emerging markets a lot better over time. Since taking over the Aberdeen Latin American Equity Fund (ticker: LAQ) in July 2009, when it was acquired from Credit Suisse, he has generated a total return of 74.47% through Nov. 10. That's about 16.5 percentage points better than its MSCI benchmark.
Paulo Fridman
Nick Robinson
Robinson, who's 32, cut his teeth managing U.S. and global funds for Aberdeen Asset Management starting a decade ago. In February 2008, he moved to London from the firm's Philadelphia offices to join its global emerging-markets team. The following summer, he relocated to São Paolo to run the fund.
"This was a remarkable opportunity to enhance an already proven fund," recalls Robinson. His strategy: pare down the its 100-plus positions to a more focused portfolio. Today, the fund holds only 49 stocks.
Robinson believes concentrated, bottom-up stock selection puts the fund into companies that can exploit the region's rapid expansion better than a broader swath of shares can. According to Morningstar, he has done just that.
Over the past 12 months through October, the MSCI Emerging Market Latin America Index was up 23.98%, in U.S. dollar terms. The net asset value of Aberdeen returned an additional 12.23 percentage points. Reduction of the closed-end fund's discount added another 2.75%, giving investors a total return of 38.96%. Performance has pushed assets up to $245 million in the U.S.-traded fund and $453 in the Luxembourg-based open-ended version (not available to U.S. residents).
Thinking outside the index is key to his outperformance. For example, being underweight struggling Petroleo Brasilerio (PBR/A)—known also as Petrobras—helped. Where the Brazilian oil giant makes up 13.15% of the MSCI EM Latin America Index, Robinson's holding was 9%. And where a leading Brazilian retailer, Lojas Renner (LREN3.Brazil), whose stock is up 62% this year, represents only 52 basis points of the index, it makes up 4.7% of Aberdeen's portfolio.
A dozen analysts and investment managers based in London and an additional analyst beside Robinson in São Paolo jointly select investments based on growing, well-managed firms selling at reasonable valuations.
"First off," he explains, "we generally invest in companies with simple, transparent business models." He then judges opportunity according to basic valuation tools. "For most sectors we use price-to-earnings multiples and cash-generation ratios, adjusting the former for any noncash distortions. This is particularly important in places like Brazil, where goodwill is deducted in the tax accounts but not in the reported accounts, so cash taxes tend to be lower than reported taxes."

Aberdeen Latin American Equity

866-839-5205

Total Returns*

1-Yr3-Yr5-Yr
Aberdeen Latin20.8%6.4%22.2%
MSCI Emer Latin Am10.0%2.6%19.9%

% Of
Top 10 HoldingsTickerPort.**
Petroleo BrasileiroPBR/A8.9%
ValeVALE/P8.8
Banco BradescoBBDC35.9
America MovilAMXL5.7
Lojas RennerLREN34.7
Multiplan EmpreendimentMULT33.9
Ultrapar ParticipacoesUGP3.7
Natura CosmeticosNATU33.6
Fomento Econo MexFMX3.4
Grupo Financiero BanorteGFNORTEO3.3
Total:
51.9%
*All returns are as of 11/17; three and five year returns are annualized. 
** As of 9/30. Sources: Morningstar; Bloomberg; company reports
He relies on conservatively conceived two-year earnings models for all companies to help determine if current prices make sense. When prices appear to have gone beyond reason, he'll take money off the table.
Aberdeen's investments are driven by several key emerging-market themes: natural resources, business development and, above all, powerful expansion of the middle class. According to Robinson, this income group has increased by 32 million [the size of Canada] in Brazil alone over the past seven years. This helps explain why two-thirds of the fund's assets are parked in the country. (About 22% is in Mexico, and 7% is in Chile.)
With communications at the core of economic growth, Robinson's fourth-largest position is Mexican telecomAmerica Movil (AMXL.Mexico), his sole stake in that sector. "Having the largest number of subscribers and highest margins, America Movil is Latin America's leading wireless carrier," says Robinson, "and its recent move into fixed lines should position it to exploit growing broadband demand serving computers and television."
In addition to synergies from bundling wireless and wireline services, he projects increasing service and data demand to shift customer usage from prepaid to more lucrative contracts. This should further propel shares, which were up 22.6% in dollar terms through Nov. 18. Selling at about 13 times expected 2011 earnings, Movil's valuation is still very attractive, he says. America Movil is expected earn $7 billion in 2010 on $41 billion in sales.
His primary concern is that the company is being too aggressive in managing its currency derivatives to try to reduce the cost of its $9 billion debt. Although it's done well with the strategy, Robinson would prefer that it simply hedge its currency position so that its debt doesn't grow.
At 5.9%, São Paolo-based Banco Bradesco (BBDC3.Brazil) is the fund's third-largest position. "Aberdeen Funds have been in the bank for years," says Robinson. The reason: It's one of the region's largest financials, providing a full range of consumer, commercial and investment-banking services. If the company meets 2010 estimates, its revenue and profits will have nearly doubled over the past five years. This year Robinson projects that the bank will make a profit of $9.7 billion on revenue of $53.4 billion. The stock is up 12% for the year through Nov. 18.
"BRADESCO IS Astable, well-managed way to play Brazilian growth," posits Robinson, "especially the expansion of consumer services, such as loans, mortgages and insurance. And these activities should increase as interest rates decline." This should mitigate the main risk to which the bank is exposed: local borrowers dependent on global economic growth.
Another pure Brazilian play in Robinson's portfolio is the high-end retailer Lojas Renner. Spun off from J.C. Penney in 2005, this department store's sales have tripled over the last five years to $1.6 billion, propelled by new store openings, its branded credit-card services and improving operating efficiencies. Helping it attract international investor support is the stock's listing on Brazil's Novo Mercado—a segment of the main exchange reserved for companies with superior corporate governance. Although Robinson has taken some profits on the surging shares, Aberdeen remains a major backer of Renner, with its 14.6% ownership of the company.
"This remains one of the most compelling ways of playing Brazil's emerging middle-class story," says Robinson.
Petrobras represented 20% of the fund's portfolio when Credit Suisse owned it, but Robinson sold off more than half of it by October 2009. As a result, he sidestepped much of the dilution from the recent $70 billion secondary offering that's financing Petrobras' acquisition (from the government) and development of massive reserves off the Brazilian coast. The shares have lost nearly 28% this year through Nov. 18, which has hit the fund's 9% position hard.
Still, Robinson remains optimistic. "There are few oil companies in the world with such high-quality reserves," he says, "and the capacity to nearly double production to nearly 4 million barrels per day by 2020 from current levels of 2.1 million barrels."
But he agrees that political risks remain: "The secondary offering showed how the company has been used by the Lula [Luiz Inácio Lula da Silva] government as a tool for fiscal policy, and we are concerned the same may occur under the incoming Rousseff [president-elect Dilma Rousseff ] government." The government received $43 billion from the stock sale.
While a small part of Latin American equity benchmarks, Chile is the most compelling country in the region, with the soundest financial and government systems. For Robinson, Banco Santander Chile (BSAN.Chile)—created by the global Spanish bank—is an effective way to play this country. "Besides directly benefiting from expanding demand for financial services, especially mortgages," observes Robinson, "we especially like to invest in firms that are controlled by established, developed-market companies that have applied their expertise in the region." A legacy position, the bank has soared 103% since Robinson took over the fund through Nov. 18.
Robinson believes the Latin American story is far from over. But he acknowledges bumps are out there. Managing rising local currencies without stalling foreign direct investment that's fueling growth requires a deft touch and a bit of luck. Despite internal growth, failure of developed-market recovery to gain traction will hurt. And despite their embrace of freer private markets, Latin American politics will always remain a potential flash point. It's something that Robinson's learned to navigate carefully.  
ERIC UHLFELDER, author of Investing in the New Europe, covers global capital markets from New York.