Writing about Advance Developing Markets last week, I noted that the largest holding is BlackRock Latin American Trust. This £210 million market cap fund is the de facto choice for most investment company investors looking for exposure to South America.
The fund is over 20 years old and over that time the region has been in and out of favour with investors and, in the bad times, most of its competitors were wound up. Despite the ups and downs and poor performance of the past year, the MSCI Latin America Index has increased six-fold over the past decade.
The BlackRock fund has not matched this record. In part, this was because of underperformance by the previous manager; in 2006 the management contract was transferred from F&C to Merrill Lynch (now BlackRock) and Will Landers became the investment manager. However, over the past five years, while the fund has been under BlackRock’s stewardship, its NAV performance has lagged the index by more than 10%.
Keeping discounts under control
What has saved the fund is its commitment to keep its discount under control by offering investors an exit of a percentage of the company, most recently 5%, at a 2% discount to net asset value at six-monthly intervals. The last tender was well oversubscribed, with 36% of the shares in issue tendered. It may be surprising then that the directors decided not to implement the tender due in September.
They cited poor markets and the potential effect on their gearing as reasons not to proceed with the tender – the implication being that the NAV would suffer if they had to raise money in these markets to finance a tender and offset some of their gearing. This, and the poor recent performance, may be why it is currently trading on a 9% discount.
Gearing is in the form of an $80 million unsecured convertible debenture that yields 3.5%. The price at which this converts into equity is being ratcheted up on 14 September to $9.83 per share – well above the current price and NAV. The change in the exercise price ought to make buying in the bonds alongside the equity more feasible.
Net gearing, after offsetting cash holdings, is still around 17% so the fund has been geared into the falling markets. The board has set a maximum limit of 25% for gearing so 17% looks quite aggressive.
When looking at the portfolio the first thing that strikes me is that most of the fund is invested in Brazil and Mexico – the rest of the continent does not get much of a look in. Argentina and Venezuela are obvious no go areas thanks to their politicians.
BlackRock does acknowledge the attractiveness of some of the other markets however but is avoiding them on liquidity grounds. For a fund of BlackRock’s size you might not think that this would be a problem but it is just a small part of a much bigger group of funds investing in the area. This asset allocation has negatively impacted its performance so far this year as most regional markets, with the notable exception of Argentina, have outperformed Brazil.
Will Landers makes the point that Brazilian equities look cheap relative to global markets as a whole. The Brazilian government is attempting to stimulate a domestic recovery, chiefly by cutting interest rates, but an improvement in sentiment may require signs of an improvement in Chinese demand and a resolution of the problems in Europe.
Signs of life in the US
Mexico is heavily dependent on exports to the US. Signs of life in the US economy and an improvement in Mexico’s ability to compete with Chinese imports are helping here but BlackRock thinks the Mexican market is looking fully valued relative to other markets. Chile is also affected by falling commodity prices because of its dependence on copper production. Nevertheless, it and the other Andean countries where the fund has relatively small exposure, are doing well.
The fund is quite focused with around 60 holdings. The need for liquidity means the portfolio is dominated by a handful of large cap companies. The largest holding is Companhia Vale do Rio Doce (CVRD), the Brazilian mining giant.
The growing evidence of a slowdown in Chinese demand hit the iron ore price hard and this had a knock-on effect on the price of CVRD. América Móvil, Carlos Slim’s Mexican mobile telecom company, is the number two holding. It is up over the year but the price has been drifting off since mid-July. Petrobras, the Brazilian oil major, is the third largest holding. Its share price has see-sawed this year in response to changes in the oil price. These three stocks make up over a quarter of the fund.
A yield of 3.8% compares favourably with its income-focused rival, Aberdeen Latin American Income, which yields 4.4% and the fees look reasonable at 0.85% of net assets. The persistent underperformance is a problem however and this will need to be tackled if the fund is not to shrink further from here.
James Carthew is a director of Sapient Research