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Market Insight 2012 Q3 Chile

Chilean investors have more reason than most to fear a China slowdown. Not only would faltering growth in the world’s most populous country negatively affect appetite for risk assets, hitting the performance of global stock markets – a sustained fall in Chinese manufacturing and construction activity would have a direct impact on Chile’s economy. Indeed, Capital…


Chilean investors have more reason than most to fear a China slowdown. Not only would faltering growth in the world’s most populous country negatively affect appetite for risk assets, hitting the performance of global stock markets – a sustained fall in Chinese manufacturing and construction activity would have a direct impact on Chile’s economy. Indeed, Capital Economics estimates that, if exports of Chilean commodities to the Asian giant fail to rise at rates seen during the past decade, Chile’s annual GDP growth could be cut by three percentage points over the next two to three years.

With so much riding on China, it was unsurprising to find Chilean institutional investors preoccupied with economic numbers emerging from Asia, when the Expert Investor Latin America research team visited Santiago in June. Many of our interviewees – who comprised fund selectors from a range of wealth managers, private banks, family offices and pension schemes – are worried about signs of slower Chinese growth, and are concerned that statistics published by the authorities might be inaccurate.

Key trends
• Chilean fund selectors are worried about Chinese growth.
• Demand for emerging market assets is likely to continue.
• The eurozone crisis has hit appetite for European equities and bonds.
• Short-dated high yield strategies are favoured.

News Roundup
• Chile’s monthly economic activity indicator rose by 5.3% year-on-year in May, according to the country’s central bank – above market expectations.
• Data from government statistics agency INE shows that Chilean unemployment was 6.7% between March and May, with female unemployment rising for the first time in 2012.
• The Central Bank of Chile kept its monetary policy interest rate at 5% in June. The Bank last changed its rate in January, with a 0.25% cut.
• Wages in Chile rose by 0.2% month- on-month and by 6.5% year-on-year in May, INE data reveals.
• Strabag, an Austrian construction group, won a contract to build tunnels at Codelco’s Chuquicamata copper pit mine in Chile. Chuquicamata is the world’s largest copper mine.
• There is a strong possibility that an El Niño weather pattern will emerge this summer, according to Japan’s weather bureau. In June 2002, the El Niño caused severe storms and flooding, impacting heavily on Chile’s economy.

Investors are similarly wary about the impact of the West’s travails on emerging nations, and sceptical that the ‘developed’ and ‘developing’ worlds are decoupling at the pace forecast by some commentators. They are also uncertain on global currencies. Many interviewees doubt that the dollar will maintain its position as the world’s main reserve currency over the long term and, despite their concerns on the outlook for China, say that the renminbi will soon become a hard currency.

This general lack of certainty on the global picture has left Chilean fund selectors cautious on the future. Half the interviewees are negative on the macroeconomic outlook over the next 12 months, with the remainder evenly split between positive and neutral views (see chart 1).


Emerging markets

Appetite for developing world equities and sovereign bonds will continue
Nevertheless, investors spy opportunities. For example, appetite for Asia Pacific equities has been robust this year, according to figures from Strategic Insight Global, a New York-based fund management research company. Inflows from Chilean state-backed pension schemes (AFPs) into Asia equity funds (excluding US-domiciled vehicles) topped $900m in Q1 (see chart 2), more than compensating for an outflow of about$800m in the final three months of 2011.

Our research indicates that buying in this sector will continue. Half of the fund selectors we spoke to say they expect to increase their broad emerging market equity allocations during the next year (see chart 3). In particular, they seek ways to take advantage of China’s moves to rebalance away from exports and towards greater domestic consumption. But interviewees complain about the quality of investable China equity funds, and highlight inconsistent manager performance.


There is a similar level of appetite for emerging market government bonds. Because of Chile’s status as a developing nation, fund selectors in Santiago regard the asset class simply as ‘sovereign debt’ and do not consider it as risky as Western investors. Our interviewees are already overweight local currency emerging market fixed income, but half of them plan to boost their allocations further.

US equities

Investors favour US stocks, focusing on real estate, technology and energy
Chilean investors also expect to increase their US equity exposure during the next year, despite their concerns over the pre-eminence of the dollar in the global economy. Strategic Insight Global data shows that North America equity funds saw broadly flat sales from pension schemes in the first quarter of 2012, following a net outflow of some $500m in the previous three months.

Yet more than two- fifths of fund selectors plan to top-up their US equity allocations, with just a third likely to reduce their weightings (see chart 4). Investors are encouraged by measures that the US government has taken to stimulate the country’s economy, and say it has handled the global economic crisis well. In particular, interviewees are interested in boosting their exposure to companies in the US real estate, technology and energy sectors.




Fund selectors plan to cut their European equity and bond exposure
In contrast, there is little appetite for European assets. Funds investing in European equities saw inflows from Chilean pension investors in the first three months of 2012. But about a third of our interviewees plan to reduce their weightings over the next year, citing the political nature of the eurozone crisis as a key concern. Less than a quarter expect to increase their allocations (see chart 5).

A similar pattern is apparent in European government debt, with 33% of investors planning to reduce their exposure to the asset class, and less than one-fifth likely to increase it (see chart 6).


High yield

Short-dated securities are preferred but questions arise over quality
Elsewhere within fixed income, interviewees are worried about the prospects for high yield. Money from investors around the world has poured into the asset class during the past year, and Chile is no exception. According to Strategic Insight Global, Chilean pension funds were responsible for net inflows of about $1.5bn and $600m into high yield corporate bond strategies, in the fourth quarter of 2011 and first quarter of 2012 respectively (see chart 7).

Interviewees remain interested in short-dated securities, which tend to exhibit lower price volatility. However, many question whether funds are now scraping the barrel in terms of quality, and ask if high yield could become the next bubble.