Q&A

Latin America Small & Mid Cap Equity

March 2012

STACY STEIMEL Managing Director Head of Latin America Equity PineBridge Investments, Santiago

Q. To what extent is the performance of Latin America small and mid cap stocks correlated to commodity prices? A. Correlation with commodity prices tends to be low in this asset class as Latin American small capitalization companies are more focused on the domestic economies. The correlations can, nevertheless, be high with commodities during specific periods given the fact that some of the underlying economies depend on commodities to generate tax revenues. During 2011, the MSCI Small Cap Index had a relatively low correlation with the S&P Commodity Index, just 0.654 compared to the Large Cap Index at 0.699, both measured in dollar terms. If you break out the commodity index into its component parts, like energy, soft commodities and metals, the correlations fall even further for small cap stocks, and particularly against our strategy. Q. Which countries or sectors do you currently favor? A. The consumer continues to be a medium term theme. Another interesting move that we have seen is an emphasis by local governments on big infrastructure projects. From Mexican ports to Colombian petroleum pipelines and Brazilian airports, these projects have been bid and are now underway. This infrastructure spending in 2012, and the anticipation of a global recovery in the second half of 2012, is lifting industrial stocks which are our second favorite theme. Valuations for Latin America are currently mixed. Whilst Colombia and Mexico are extremely stretched, both Brazil and Peru are particularly attractive on a valuation basis despite the year to date rally in the region. While Chile looks expensive on

Q. What is your outlook for Latin American small and mid cap equity this year? A. The performance of small and mid cap stocks in Latin America will depend on fundamentals and flows. We are extremely positive on the fundamentals. Funds flows have also been extremely positive for the region in 2012, rising to US $4 billion. There are two trends worth explaining with respect to flows: first, the bulk of the flows have come from dedicated global emerging market funds and second, the flows have been predominantly into Exchange Traded Funds, dissipating their impact on any individual stocks. We are one-third of the way through fourth quarter 2011 earnings season and it has not been a stellar quarter so far. Only 23% of Latin American MSCI companies have reported above consensus numbers. While it is still early days, and Mexico and Brazil have fared better than Chile which is already half finished, it is important to highlight that the Q4 earnings season is a lagging indicator given the sharp GDP recovery we expect from here. Another interesting point to make with respect to small cap stocks, is that their performance crossed over large cap stocks in December and since December 1st, they have outperformed their large cap stocks by 5.17% (Source: Bloomberg). This is typical of the behavior that we witnessed in 2009 when Latin America small cap stocks outperformed their large cap counterparts by 20% in the post US financial crisis rebound.

its own headline, it is actually trading at a discount to its own history. Market events in 2011 are still affecting the multiples of retail companies and there is pending legislation that could have an important effect on the sector. Further, fourth quarter earnings have been soft as half of the companies have already divulged results. Thus, we are particularly keen on the Andean countries, ex-Chile, and a rerating in Brazil. In Mexico, we urge caution as we move toward the hotly contested Presidential elections at mid-year. Q. Are there any sectors you are avoiding at the moment? A. In 2011, defensive sectors like utilities and telecommunications were the best performers. 2012 to date has been quite the opposite, with consumer discretionary and interest rate sensitive sectors leading the charge. Many of the names that underperformed in 2011, particularly some of the industrial names, have started to outperform again. Q. What do you consider as the biggest risks for investing in Latin America small cap equities in 2012? A. Although Latin America is less exposed to European sovereign and US growth concerns, the low liquidity of the asset class is an issue to consider, but looking to the medium term creates a clear buying opportunity. Risks in Latin America are more geared toward domestic issues such as governments trying to attract investors to fund infrastructure projects or consumer companies managing to accelerate growth organically or through M&A. We firmly believe favorable demographics, the emerging middle class, economic formalization and market friendly governments in Latin America are enough to mitigate the effects of a potential external shock.

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