The quick view
- Chile, Peru and Colombia are facing social and political upheaval amid pressure to deliver more inclusive growth.
- Although challenges remain, all three countries should be able to retain their investment-grade ratings.
- The recent sell-off has created opportunities, particularly in Colombia and Peru.
- In particular, we view the underperformance of Colombian local bonds and hard-currency debt as a chance to add risk.
- In monitoring opportunities, ESG considerations must remain front-of-mind for investors.
Chile, Peru and Colombia are at pivotal junctures. Each of these investment-grade countries is experiencing social and political upheaval amid pressure to deliver more inclusive growth and public services. We visited them last week, during a research trip that shed valuable light on their investment potential.
Our visit also underlined the critical importance for investors in emerging market debt of taking account of environmental, social and governance (ESG) considerations. In Latin America as elsewhere, understanding the causes and drivers of a broad range of ESG-related issues – including inequality, social exclusion, access to justice and the strength of institutions – is essential when seeking to build a robust and resilient portfolio.
Colombia: encouraging signs
With its greater focus on social spending and inclusive growth, Colombia has the lowest credit rating and highest debt/GDP of the three nations. But a more equal society has also made the country relatively stable.
We were encouraged to discover that the central bank’s newest board member is focused on maintaining current healthy growth rates without overheating, which we also see as an immediate challenge. Encouragingly, addressing the long-term stagnation of Colombia’s non-commodity exports — and its consequent reliance on oil, coal and coffee — finally appears to be becoming a bigger policy priority.
Chile: pressing need for change
The need for change is more pressing in Chile, where we expect social spending to start to increase and a less strict approach to macroeconomic balance and austerity. We do not think the conservative Chilean electorate would jeopardise economic stability, but some downward convergence of the country’s long-term credit rating towards that of Colombia should be expected.
Overall, the fact that both Chile and Peru have considerable capacity to increase taxes to fund social spending leaves us optimistic that they will be able to maintain sensible fiscal rules and hold onto their investment-grade status. We will be watching carefully the evolution of the new Chilean constitution, which must include sweeping measures to improve market competition and reduce the protection currently enjoyed by the country’s elites and oligopolistic industries.
Peru: inequality must be addressed
In Peru, the pressure to increase social spending is less intense, partly because Peruvian institutions retain popular support as the pain of hyperinflation in the 1980s has not been forgotten. We were pleased to engage with Peru’s government on the new EITI 2030 vision for mining. But much more must be done to address racial inequality and social exclusion in Peru. More generally, we are positive on the steps taken with the World Bank to improve public expenditure management. But we continue to penalise Peru in our ESG scoring for its weak judiciary.
Portfolio positioning and outlook
- Colombia: We have been underweight Colombian local bonds and sovereign credit, and have been cautious on the Colombian peso (COP). We remain cautious in the short-term on the COP until the current-account deficit starts to shrink in 2020. But we viewed the recent underperformance of Colombian local bonds and hard-currency debt as an opportunity to add risk; we did not expect the November strike to be too disruptive and we believed fear of contagion from Chile to be overdone.
- Peru: We see much less risk in Peru from the upcoming elections. A positive growth and inflation picture should unfold in 2020. Any further underperformance in the local market would make unhedged local bonds more attractive.
- Chile: The situation in Chile remains more fluid, but our local discussions lead us to believe that local ownership of US dollar-denominated assets is already higher than the market thinks. Consequently, capital-flight risks have been somewhat overdone in the recent market price action. Covering an underweight in local bonds and hard-currency debt makes sense to us, although opportunities in the Chilean peso (CLP) will remain more tactical.
ESG and engagement will remain key
Our research trip has cemented our belief that institutions in Colombia, Peru and Chile are strong enough to navigate the current demands for change. However risks remain, not least the heightened longer-term threat of increased populism, as seen elsewhere.
As well as helping us to assess the extent to which the recent Andean market sell-off has created opportunities, our recent visit to Latin America has reinforced the central roles that ESG analysis and engagement have to play in emerging market debt investing. We will maintain our focus on these critical areas of research. On that note, we are working with all three governments in the design and planning of upcoming green/ESG bond issuances.
Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
The value of investments, and any income generated from them, can fall as well as rise.
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