cover story: LATAM CAPITAL MARKETS
More Latin American issuers are selling local-currency bonds, and the bet is paying off with strong demand which market players expect will grow. That bodes well for the development the asset class.
By Charles Newbery and Hernán Goicochea
Investors can spend a lot of time assessing risks for financial gain. It’s not always easy. Pandemics and wars can mess up forecasts, and gauging the future path of interest rates is hard. A decline in the 10-year US Treasury yield to 3.5% at the end of January from a peak of 4.25% last October was a sign of improving market sentiment for a sooner-than-expected tempering of US interest rate hikes. This sparked a rise in bonds and stocks. But the rally soon fizzled and the 10-year yield crept back up. Global markets were subsequently roiled by turmoil in the banking sector which has upended forecasts for the monetary policy in the US and Europe - and heralded the return of risk aversion globally.
This volatility has made investors more selective in the search for returns. Despite the recent global market anxiety, a number of factors could now support the investment case for Latin American assets and one long-neglected asset class in the region could gain over the longer-term: local-currency bonds.
“Latin America, as a whole, is in better shape than most people had expected,” Carlos García Moreno, CFO of Mexican telecoms giant América Móvil, said at LatinFinance’s Latin American Capital Markets Summit on January 26 in New York. “This is going to be extremely good for local markets.”
América Móvil found this out last November. The firm raised the equivalent of $1.24 billion from the sale of Mexican peso-denominated notes in the local market for the first time in years. It sold 10-year notes at a fixed rate of 9.52% and 15-year notes at 4.84%, plus two other shorter-term notes.
“There is a lot of pent-up demand in Mexico,” he said.
América Móvil plans to sell more local-currency notes in both the local and international markets out of a new global notes program to be launched this year, betting on this growing investor demand for the region after it fell off the radar for several years.
Foreign participation in local-currency government bonds in Peru fell to 44% at the end of 2022 from a high of 56% in 2013, according to the Institute of International Finance (IIF). The decline has been similar in Mexico, at 17% from 37% over the same timeframe. The participation has fallen to 9.4% in Brazil from a peak of 20% in 2015. Only in Colombia, has the rate held steady at around 25% since 2017, the data show.
But a number of things are going in Latin America's favor, which experts say should bode well for investor demand in the region's local markets – and for portfolio allocations to local currency debt in particular. For a start, the region is now widely considered more economically and politically stable than other emerging markets including Russia, Turkey and South Africa.
Another potential driver of an increase in demand for local markets is China. The reopening of the world’s second-largest economy after abandoning a zero-COVID policy is expected to spur economic growth in Latin America, led by demand for commodities, manufacturing services and tourism. “The majority of the economic impact” of this for emerging markets “is ahead of us,” Alejo Czerwonko, chief investment officer for emerging markets in the Americas at UBS Global Wealth Management in New York, said at a February 10 Moody’s Investors Service summit.
Another driver will be a sustained decline in long-term US rates, which could bring an appreciation of local currencies and a weakening of the US dollar.
“There are investors out there with cash, and these investors are keen to ride the reduction in long-term rates, and if you think the reduction in long-term rates in the US is going to be a percentage point, think about what it can be in pesos. It can be probably 4 percentage points,” García Moreno at América Móvil said. “We are going to see a lot of international investors moving into the local markets.”
“We are going to see a lot of international investors moving into the local markets.”
– Carlos García Moreno
It has already started. The net portfolio flows into emerging markets debt totaled $42.2 billion in January, the highest since $46.8 billion in June 2021, according to IIF. Latin America received $7.8 billion of these flows in January, more than double the $3.2 billion average over the previous 12 months and the highest since $11.2 billion in March 2022, the data show.
“I see an environment in which the differential between local rates and US rates will widen still a little bit, but then they will start to come down, with currencies appreciating in practically all of the countries” in Latin America, García Moreno said. “This trend is already starting to happen in Chile and Mexico. It will happen next in Brazil and Colombia.”
Low external imbalances in Latin America are helping central banks to sustain exchange rates, feeding expectations of a decline in interest rates and better-than-expected economic growth.
Mexico may benefit the most from this trend. The country is investment grade and foreign direct investment is rising for nearshoring, including recently from companies like Tesla, a big US electric carmaker. Mexico also has a well-defined yield curve from one to 30 years, and the peso likely will remain stable or even appreciate “as more people jump into this game,” García Moreno said. “Investors will win on the reduction of rates, and they will win on the continued appreciation of the peso.”
The good thing for issuers is that the demand potential is large for bonds in the local market.
“The flows that go to Latin America are not so large, so the capacity to grow is huge,” says Alfonso García Mora, vice president for Europe, Latin America and the Caribbean at the International Finance Corporation.
A key for attracting more foreign capital is a sustainable economy, he adds. “The more that we can manage to have inclusive growth and we manage to have a more diverse and economic structure, the easier it will be to attract international capital.”
Mexican cement maker Cemex is looking at the local market, encouraged by this potential growth in demand.
“Most foreign investors are underweight on local exposure,” Maher Al-Haffar, CFO of Cemex, said at the LatinFinance event. “If you look at the long-term peso bonds in Mexico, the foreign ownership is almost at a historic low, and the local ownership is at a historic high.”
As more investment flows into the local markets, this will make more financing available.
“We think there are opportunities probably as rates ease off more” for financing, including in Mexico, Al-Haar said. “We are looking at the peso. When we see the peso at these levels, it is a very interesting entrance opportunity. We’re always looking to diversify.”
Jaime Reusche, a senior credit officer at Moody’s, says this strategy is gaining in the region. “The idea is to always have a portfolio of options for financing so that you don’t have to rely or put all of your eggs in one basket,” he says. “You have more options, you have lower costs, you have a much deeper investor pool.”
Orlando Ferreira, CFO of IDB Invest, the private sector affiliate of the Inter-American Development Bank, says local-currency bonds are catching on elsewhere in the region. In Paraguay, its first bond issue was 90% bought by the national pension fund, the latest by 15 investors. “That’s how you grow in those markets,” he says. “Investors come to buy your bond, but they also take a look and say, “Oh, there’s this other bond from this other company that might be also attractive.’”
There are challenges. A big one is how to attract foreign investors to local-currency bonds, and, more gernally, higher-risk fixed income securities in Latin America.
Sarah Leshner Carvalho, an emerging markets fixed income investor at Capital Group in New York, points out that low trading liquidity can keep investors from taking the plunge.
“It is the pursuit of liquidity – that is a huge challenge for us in the local markets,” Leshner Carvalho said at LatinFinance’s event.
“It is the pursuit of liquidity – that is a huge challenge for us in the local markets.”
– Sarah Leshner Carvalho
Joe Bormann, head of Latin America corporate ratings at Fitch Ratings, says the inability to exit a local-currency bond is a deterrent for investors, who may have to hold it in their portfolio for a long period of time or until maturity, exposing them to currency risk.
At América Móvil, its strategy for attracting investors involves using a group of market makers to ensure liquidity, helping to ease the concern of a tough exit, García Moreno says.
Having liquidity will be important this year when selectivity is expected to dominate investment decisions.
“You want to buy credits that you can live through the cycle with,” such as corporates that won’t suffer refinancing challenges during a downturn, Xavier Vegas, head of global credit strategy at JPMorgan, said at the Moody’s event. His focus will be on “high-quality credits that trade similar to US high yield but in all reality have much better balance sheets and much better cash flow generation.”
Czerwonko at UBS sees opportunities in Latin American corporate bonds. “We have well-managed companies that have taken advantage of prior years of abundant liquidity to do very smart liability management operations,” he said. “We have terrific leaders in these corporations that are able to manage varying levels of difficulties.”
The bulk of the opportunities are in national oil companies, low-cost miners, leading financial institutions, and some food and beverage companies, Czerwonko said. “Corporates are relatively more attractive than sovereigns when it comes to Latin America.”
There is still a sense of caution. Ricardo Torresi, investment manager for Latin America at Zurich Global Investment Management, said that as Latin American issuers compete for financing with European and US high-yield issuers, local risks can deter investors, in particular politics. Frequent changes in business rules – or the uncertainty of potential changes – are a major turnoff, he said, citing the example of the Brazilian president’s pressure on the central bank to increase the inflation target and reduce interest rates, and Argentina’s ban on raising energy tariffs.
A spate of bankruptcies in Brazil is also damping demand for corporate bonds there, in particular a case of accounting inconsistencies that has toppled Americanas, a huge retailer with investors including BlackRock and Capital Group.
Perhaps more alarming, the international markets remain volatile.
“We still have a war going on in Europe, and a wrong misstep there could throw a lot of these things into a curve ball,” Al-Haffar at Cemex said. “We can’t just sail into this thinking the crisis is behind us.” LF