Investment Adviser:

INCA Investments, LLC

(May 2014)

Latin American markets as a whole have been underperforming their emerging market peers for some time. What do you put this underperformance down to?

The overall concern that China, the world’s second largest economy, is facing a steepening decline in its economic growth rate has triggered a decline in the prices of commodities while causing a slowdown for those Latin American countries that are significant commodity exporters.

However, you have previously said that this underperformance has created buying opportunities in specific Latin American stocks. How is this so and are there any particular sectors/ stocks where this has been most apparent?

The relatively poor performance of the Latin American markets is creating buying opportunities in specific Latin American stocks which not only trade at lower valuations, but are often accompanied by higher growth rates. This has been most apparent in Brazilian stocks.

Could you explain to us your stock picking process in such a situation?

Our stock picking process does not change as we continue to look for those stocks that provide the best upside given their particular risk profile.

The performance of some Latin American stock indexes in recent months has been affected by concerns over a slowing Chinese economy because of commodity trade. If this continues to be the case, to what extent will it affect the Fund portfolio, either positively in creating buying opportunities, or negatively?

It would positively affect the portfolio if it is based purely on concerns, but it could negatively affect the portfolio if the Chinese economy does actually experience a significant slowdown.

You have previously suggested that pessimism over Latin American markets’ prospects has led to a good supply of bargain stocks. Is it easier, or preferable, to manage portfolios in that kind of environment or is there a level of investor pessimism that eventually makes it impossible to find any bargains?

We believe that the higher the pessimism, the better chance there is to find bargains.

The US Federal Reserve’s monetary stimulus tapering was widely expected to negatively affect emerging markets, especially Latin America. Now this is well underway, do you think markets are beginning, or have to a large extent already, priced it in?

We believe Latin American shares have largely priced in this concern.

Elections are planned in Brazil later this year. To what extent is their outcome likely to affect Brazilian markets in the short and medium to long term?

Our expectation is that President Dilma will be re-elected, therefore we retain our cautious view on its economy.  However, we believe that the effect will be relatively muted.

Brazil was, just a few years ago, hailed as one the brightest emerging market prospects. But its economy appears to be faltering and many investors seem to be taking a less positive view of the country. What, in your view, needs to, or indeed can, be done to get the Brazilian economy back on track?

To get the Brazilian economy back on track, we believe the government needs to reduce its intervention in the Brazilian economic model.

Could you give some examples of where specifically its intervention needs to be reduced?

Certainly – but we believe this is more of a general situation. Amid economic uncertainty, it would be more encouraging to see a government that is willing to do some belt-tightening rather than hit the income/growth potential of industries/companies that contribute to employment, wage and GDP growth. Specific sectors that come to mind include electric utilities and beer & beverage, as most recent examples.

In the beer & beverage segment, just this week, the government published an unexpected and much-feared update of the reference price upon which excise taxes on cold drinks are calculated. Historically the reference price is based on retail prices, but hadn’t been updated since October 2012.  It seems to infer an ultimate increase in beer prices of 5-6% for players like Ambev.

For context, it is important to highlight that this is the second tax increase in this segment in less than two months and appears to be an attempt to maximize the opportunities the sector is supposed to enjoy when the World Cup starts in June.

More importantly, this is yet another measure aimed at bolstering tax revenues at a time when the primary surplus is deteriorating and the government has a growing and looming energy crisis bill to pay (the BRL11bn loan announced in March should have been tapped out by the end of April). To add insult to injury, the government will now need more resources as well to pay for the increase to Bolsa Familia funds while compensating for reduced personal income tax rates at lower income brackets. These last two measures have only just been announced by the current president in a move that is being widely decried as electoral in nature (Brazilian elections are set for early October and the latest polls show a deterioration in the current ruling party’s standing).

On the subject of much-needed reforms, what is your opinion of the progress of reforms in Mexico – a country widely as seen as having the best potential of any market in the region?

We view the Mexican reforms as positive for the country on a long term basis. However, it will take a long time for the beneficial effects of the reforms to be felt.

Could you give some examples of specific reforms and when you say a ‘long time’ do you mean more than two or three years?

We certainly recognize that the change in the federal government in Mexico in December of 2012 created reform momentum. In fact, in contrast to Brazil, we believe at the heart of the reform agenda is a boost in revenues in order to address the shortfalls in Mexico’s human capital and physical infrastructure that have cost Mexico so deeply on the growth front.

Unfortunately, we believe it will take time to feel the beneficial effects for two key reasons: 1) implementation and execution of wide-sweeping reforms is difficult, bureaucratic and politicized and inevitably takes longer than it should.  2) attempts at reform have collided with a sluggish economic environment, which can hinder some initiatives.

More specifically, it is difficult to talk about the timing of benefits coming through because, as we stand today, very little has been done in terms of so-called "secondary laws", which are necessary for the implementation of reforms. For example, in December, energy reform was approved at constitutional level - which boiled down to changing a few words in the constitution to end the Pemex/CFE monopoly and allow private/foreign capital in -- but the "secondary laws" (i.e. enabling legislation) would include types of contracts, taxation, forming regulators, etc.

Congress pledged to pass everything by April 30 but it has achieved very little.  Legislators have already said that they will need further special sessions to try to approve pending secondary laws - specifically telecom, political/electoral and energy.  The other "big" one, namely anti-trust, was approved very recently.

Despite the underperformance of the region and the relatively less positive perception of the Latin American markets at the moment, if you were asked why someone should invest in the region now, what would you say to them?

Latin American economic prospects remain bright and company valuations have come down to very attractive levels.

What do you see as the prospects for the region over the next six months?

It is difficult to say and our investment style involves a considerably longer term investment horizon anyway. However, we do feel that, in general, Latin American economies are relatively strong and should perform well in the long term.


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