Issue 5
Latin Art on the Auction Block
Best Practices for LatAm Fund Managers
Mexican
Construction Lending 1
Contents
What’s inside: Argentine Wind Power A solid investment opportunity in Argentina’s market for wind energy
Page 4
Vanilla Investment potential of the world’s second most expensive spice
Page 9
The Latin American Trust Patricio Abal & Gonzalo Oliva-Beltrán explore a useful tool in project finance.
Page 12
A New Era for Investment in Argentina Javier Canosa discusses post crisis investment issues in Argentina
Page 16
Mexico: Superstar Player of the Emerging Economies Latin America’s newest investment beacon
Page 21
Cuba: Return to capitalism?
Page 24
Merlin Securities’ Best Practices for Latin American Fund Managers
Page 28
Christie’s Latin Art Sale Breaks $20 Million Dollars An exclusive interview with Virgilio Garza – Head of Latin American Art at Christie’s NY
Page 30
Chinese Brazilian Trade Ties Continue to Grow
Page 35
Fine Wine Investors Thank Latin America for a Healthy Profit Charlie Martin discusses the ways in which investors can diversify their portfolio’s asset base
Page 38
Nordeste Invest : Coming to terms with a new reality Mark McHugh discusses the resilience of the Brazilian Real Estate Economy
Page 42
Lending Opportunities In Mexican Affordable Housing Mexico’s sovereign debt looks more attractive at present than that of any other G-8 country
Page 46
LatAm Real Estate Index Looking at listed equities as proxy for private equity real estate investing in Latin America
Page 49
Forex: The World Cup Effect The World Cup soccer tournament has shown a drop in implied volatility
Page 54
Investment Analysts Try Their Luck with World Cup
Page 56
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Letter from the Editor
V
olatility creates opportunities for the greatest returns though clearly matching those returns with a comparable possibility of loss. This dynamism is the result of constant changes in every aspect of an emerging market. To deem the past months within Latin America as ‘dynamic’ would be somewhat of an understatement. At the forefront of the news we must touch on the World Cup seeing the small but stable Uruguay surpassing football favorites Brazil and Argentina, tens of thousands of barrels of crude oil pumping daily into the Gulf of Mexico, and—surely the most influential recent event in the region—elections sweeping across Latin America. As other economies struggle to recover from the financial doldrums of the past two years, this region works on political restructuring and infrastructure improvements which will see LatAm moving forward as the rest of the world attempts to regain lost ground. All eyes will be watching the Brazilian election as a political shift in the region’s powerhouse could have a serious effect on investment decisions for 2011. Perhaps the prosperity of Brazil will find its way to Argentina, as a change at the Casa Rosada might bring more than football games on local television. The BP leak has yet to be resolved, and with damage equal to multiple Exxon Valdez spills, the full extent of the damage will not be known for some time.
Contributors Managing Editor
Nate Suppaiah
Content Editor
Amanda Carter
Public Relations Director
Tiffany Joy Swenson
Marketing Director
Hannah Olmstead
Contributors
Stephen Kaczor Kevin Sollitt Marc Rogers Particio Abal Gonzalo Oliva-Beltrán Mark McHugh Bernard Lapointe Charlie Martin Tessa Albrecht Ron Suber Melanie Davis Lawrence McDaniel Javier Canosa Vonnell I. Martinez James T. Anderson
Design
Arman Srsa
US Sales
David Gorman
Consultants
Adam Berkowitz Tyler Ulrich Jennifer Peck Lydia Holden
Art photographs
Provided by Christies
As we move into the third quarter, there are many issues and events to keep an eye on, all of which have the potential to crucially impact our portfolios. Alternative Latin Investor will continue to be your top resource covering these developments and their influence on alternative assets.
Contact: Avellaneda 206 piso 3 dept C Buenos Aires 1405 Argentina (202) 905-0378 info@alternativelatininvestor.com;
2010 Alternative Latin Investor, No statement in this magazine is to be construed as a recommendation for or against any particular investments. Neither this publication nor any part of it may be reproduced in any form or by any means without prior consent of Alternative Latin Investor.
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Renewable Energy
Argentine
Wind Power
A
██ By Melanie Davis
rgentina has some of the world’s most favorable environmental and geological conditions for wind energy generation, although to date this market position is yet to be fully utilized. At a time when renewable energy sources are proven and have demonstrated their investment potential in Europe, the US and Asia, Latin America remains an untapped opportunity. The economic results of governmental research demonstrate a solid investment opportunity in Argentina’s market for wind energy, coupled with rising energy prices and a national energy deficit. Companies such as Nowa energías that specialize in the complete management of renewable investment projects are already working with landowners and energy investors to develop the market foundations.
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Renewable Energy In 2009, the global installed wind energy capacity reached 159,213 MW. Just 8 years earlier, this capacity was only 15% of where we are today, and in the next 3 years, the total is expected to double according to the World Wind Energy Association. This rate of growth in an industry which is central to the lives of every individual, every business and every country in order to maintain economic stability and development, has and will continue to catch the attention of global investors. Latin America is an unexplored territory for wind energy generation, which to date has been dominated by Europe, North America and Asia. The Latin American wind energy potential however is vast. Untapped and ideal natural resources demonstrated by the continent’s geography and available land area for large-scale wind, is the first green light for investment. Secondly, renewable technology has been successfully tried and tested for years in pioneering continents and the challenges and barriers to implementation have been recognized and understood - the wheel has already been invented and the risk contained. In addition, traditional alternatives for energy generation are becoming increasingly scarce and dangerous, as recently reminded with the BP oil spill in the Gulf of Mexico. All this, whilst energy demand and price continues to rise, cre-
ates a marketplace for renewable technologies in Latin America that neither investors nor governments can turn down or ignore. As the global energy markets change, Latin America is starting to join the revolution. The fundamental conditions for a wind farm to be economically viable are the existence of steady winds with a factor and proximity to electricity transmission networks. Over 35% of Argentina, predominantly the Patagonian region, demonstrates environmental conditions that are ideally suited to wind energy generation. In Argentina the ball has already started moving, with the government providing new opportunities to buy and sell energy generated via renewable installations greater than 1 MW at a national level. Faced with rising electricity demand (over 6% annually) and declining reserve margins, the government of Argentina is in the process of commissioning large projects, both in the generation and transmission sectors. To keep up with rising demand, it is estimated that about 1,000 MW of new generation capacity are needed each year; taking into account the capacity factors recorded and the theoretical potential, wind generation in Argentina could reach more than 2,000 GW.
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Renewable Energy During 2008, Argentina spent nearly $1,800 Million USD in fuel imported liquid and heat source power purchased from neighboring countries. That money was for the generation and purchase of 7,700 GWh, or units of electricity, resulting in a cost of 230 USD / MWh. If only 15% of the initial expenditure was invested to purchase wind power, nearly 700 MW of this renewable power could have been installed, attracting investments of 1,500 Million USD. Energy generated by these wind farms would continue to provide a national power supply for over 20 years, so state policy in this regard would replace “expenditure” by “investment”, as well as result in significant savings for the system. With constraints of gas production in Argentina, limited transport capacity of gas from Bolivia, the high cost of Fuel and Oil and the absence of large hydro and nuclear projects, which would be unlikely to fill the fore-coming energy gap in time, an Argentine government initiative, GENREN, was launched to promote national renewable energy generation. The first tender process at the end of 2009 opened the market for wind power projects in Argentina up to a total new capacity of 500 MW. The GEN-
REN initiative went on to set national targets to supply 8% of electricity consumption from renewable energy sources by the year 2016. According to a report by the Argentina Chamber for Renewable Energy in 2009 entitled ‘’Argentina’s Wind Energy Status’’, if Argentina met the projections of the Department of Energy’s Office, investment in the sector would be between 2,200 and 2,700 Million USD until 2016 plus 800-1100 Million USD until 2025. It is estimated that by this date, wind energy generation in Argentina could be equivalent to consumption of about 1 million households every year. Furthermore, when comparing the emissions of greenhouse gases from the various sources of energy technologies, each MWh of electricity generated by wind energy has a substantially lower impact on the environment with respect to fossil fuel generation. The potential for renewable energy investment by both landowners and energy investors is at the beginning of a rapid growth curve in Argentina. One company established to support this growth is Nowa energías, who aims to bring a new concept to both energy generation and consumption. Based in Buenos Aires, Nowa provides a professional, integrated
Energy generated by these wind farms would continue to provide a national power supply for over 20 years, so state policy in this regard would replace “expenditure” with“investment,” as well as result in significant savings for the system.
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Renewable Energy
approach to energy challenges in Latin America. The company’s director, Cristian Sainz, also leads the Argentina Wind Energy Association, and is therefore well positioned to provide solutions, analyses and project expertise for individuals, businesses, land owners and energy investors to move beyond the current energy constraints by providing complete project support and guidance through the administration process. Landowners now have the opportunity to generate an additional income to agricultural or livestock with a marginal land area, as each wind tower is only several meters in diameter. Investment is also needed to build and install wind turbine generators and connections to electricity transmission networks. As an example, a wind farm of 50 MW can be installed in an area of about 500 ha, which will involve the installation of a minimum of 25 wind turbines and a total investment of about 110 Million USD. The landowner will sign an agreement with the investor for a term usually fixed at 20 years. In return for this agreement, the landowner will receive an annual fee per MW, which will depend on the predicted capacity of generation corresponding to the land area, the known intensity of the wind and the proximity to a network electricity transmission. Assuming that the fee is fixed for power generation at 1,500 USD per MW, the landowner of a 50 MW wind farm could lead to a marginal income of 75,000 USD per year. Nowa works with landowners and investors to perform all studies and formalities required for project development. After obtaining the necessary approval by the regulatory authority and incorporating an investor, Nowa can complete the project
investment, construction bid and the sale of future generation. Cristian Sainz says ‘’Nowa’s renewable energy investment projects present a free opportunity for land owners to generate a sustainable, marginal profit without any investment while contributing to generate clean energy for the society.’’ According to the Argentine Renewable Energy Chamber, with total costs considered, investment in suitable wind generation sites would be appropriate for Argentina even with oil prices lower than the 60-65 USD / barrel. Such a price has not been available in the Oil market since this time last year indicating that, even before oil inflation costs are forecast, Latin America and especially Argentina are prime investment energy markets waiting to be exploited.
Author Biography: Melanie Davis has over 6 years experience working with leading companies in the renewable energy sector across Europe and Latin America. She has extensive knowledge of the business and communication of renewable technologies and markets. She has worked alongside renewable energy leaders and governments to position and promote the growth of the sector as a financially viable opportunity, using both energy efficiency to optimize energy use and renewable technologies to generate clean energy.
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V
Vanilla
Agribusiness
██ by Stephen Kaczor
anilla has been one of the world’s favorite fragrances and flavors since arriving in Europe from Mexico. It is the second most expensive spice after saffron. Today, the food industry uses mostly imitation vanilla flavoring, but there is nothing like real vanilla beans from the orchid native to Mexico, now grown in tropical countries worldwide.
██ History
██ Production
Olmec farmers from the Gulf of Mexico’s Veracruz area were the first to cultivate vanilla, originally used to flavor cocoa to make chocolate over 3500 years ago. In the 1400’s, the Aztecs conquered the Totonac Indians, ancestors of the Olmecs, who paid tribute to the conquerors with vanilla beans. In the 1520’s Cortes, after conquering the Aztecs, introduced vanilla to Europe. Queen Elizabeth I was an early promoter, according to historical texts.
The vanilla orchid, Vanilla planifolia, grows naturally only in the tropics. It is a climbing vine that must be manipulated to encourage flowering and to keep flowers within reach for hand pollination and harvest. Trees or bamboo frames can be used as supports. The wonderful flavor comes from the fruit, which is the product of pollination. The orchid has never pollinated naturally outside of Mexico and Central America where a native bee, the Melapona, had adapted to the task.
Mexico had the monopoly on vanilla production until Edmond Albius, an ex slave, discovered a technique of hand pollinating vanilla flowers in Madagascar in 1841. Soon the French were creating vanilla plantations in their territories in the Indian Ocean, Comoros and Madagascar. In the 1900’s, long before BP flooded the Gulf of Mexico with oil, petroleum companies on the Gulf destroyed the natural forests, which were home to the indigenous vanilla orchid, and Mexico’s vanilla production fell rapidly. Today Mexico produces only 2% of its peak vanilla production. Eighty percent of the world’s vanilla is produced in Madagascar and Indonesia. Shade, humidity, and low-cost labor are three keys to good yields. Extensive cultivation notes are available online, but here are the basics.
██ Opportunity
Hand pollinating was pioneered using a bamboo tool to separate the anther and the stigma so that the pollen can be transferred across the membrane that separates them. The flowers fold the same day they bloom, so vanilla farmers must check for new blooms daily in order to obtain the desired fruit. Once the fruits mature, they are harvested, cured, dried, graded, bundled, wrapped in paraffin paper and stored in metal or carton boxes. The curing process is important. Planifolia vanilla beans must be “killed” after harvest to stop growth. The method of killing will produce a unique vanilla bean flavor. There are water and sun curing methods. The major competition is vanillin, a caustic compound derived from a waste product of the wood pulp industry and today commonly used in flavoring foods. For medicinal oils, however, and for chefs that are culinary purists, real vanilla is required.
In the past decade, typhoons have damaged Madagascar’s production almost annually. They have also slowed India’s entry into the industry.
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Agribusiness Funds
██ Case Study: Hawaii Jim Reddekopp began growing vanilla with 500 plants in Kona in 2000. Production has since grown to fill a 30,000 square foot greenhouse on the Hamakua coast that is home to 10,800 vanilla plants. This was the beginning of the Hawaiian Vanilla Company. Most of U.S. imports are for low quality beans, leaving the “high-end” market available for serious growers like HVC, which produces 5,500 lbs. of vanilla beans annually with just five workers. “We have never gone to anybody – they have all come to us,” Jim’s father said, referring to customers, print and TV media and others. “Since vanilla is an orchid, it can be readily grown there on the “Orchid Isle,” but it takes dedicated growers to pollinate the flower on the one day it is fertile and to harvest the beans months later for processing.“ HVC sells their top-grade beans for $150/lb. and can’t keep up with demand. (www.hawaiianvanilla.com) “At least we can say that vanilla is paying for itself”, the senior Redekopp says, suggesting there is a market for single-source gourmet Vanilla.
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Agribusiness Funds Funds
██ Case Study: Costa Rica Villa Vanilla is a biodynamic farm selling certified organic vanilla beans and Ceylon or True cinnamon online and many other spices for national market. (www.rainforestspices.com) Their vanilla plantation incorporates a unique ecosystem with flora and fauna diversity sufficient to discourage disease, stress and land use problems associated with single-crop agriculture. Villa Vanilla has been certified organic since 1992 and Demeter/biodynamic since 2000. Henry Karczynski is the farm’s German-born, USA educated manager. He developed the biodynamic approach as a remedy to blight. His farm is close to Manuel Antonio National Park, which has developed into a spice farm tour popular with area tourists.
Stephen Kaczor is a Seattle-based writer, entrepreneur, and consultant. He is a partner at International Market Resources, a Latin American trade consultancy, and the founder of Changes In Latitude, a travel company. The focus of Stephen’s consulting is strategic market development, research & management. In addition to consulting and writing, he is passionate about Latin American culture, travel, and sustainable agriculture.
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The Latin American Trust ██ Patricio Abal & Gonzalo Oliva-Beltrán
P
roject finance has been the solution for financing infrastructure needs across the world for many years now, and Latin America has been no exception. The vast amount of debt and capital needed coupled with the risk involved in large-scale projects makes this technique one of the few alternatives available in the region.
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Infrastructure The Latin American Trust, also known as fideicomiso, has proven to be a useful tool in project finance. Since its regulation, regional governments have been able to attract more private sector resources into infrastructure development works. Particularly the fideicomiso is used to guarantee obligations, access domestic and international capital markets and carry out projects such as the “special purpose vehicle” (SPV) needed to contain all the contractual and financial relationships of the project. Large-scale initiatives such as the expansion of the gas transportation capacity in Argentina, the Bogotá-Girardot highway in Colombia and the financing of operations of several Peruvian airports are examples of works that are using the fideicomiso. The Latin American Trust is a contract by which a person (settlor) transfers a group of assets (physical or non physical) in fiduciary property to another (trustee). It is the job of the trustee to administer the assets in benefit of a predetermined beneficiary. Upon completion of the agreement the assets are transferred to the beneficiary, the settlor or a residual beneficiary. It is important to highlight the “bankruptcy remote” nature of the fideicomiso, which means that the assets transferred constitute a special patrimony separated from that of the persons mentioned and therefore not subject to the aggression of their creditors.
As was said, the fideicomiso is also used for financial purposes as a vehicle to securitize assets. In this case the trustee is a financial institution or a corporation especially authorized to act as a financial trustee and the beneficiaries are the holders of debt securities issued by the trust and backed with the trust’s patrimony. Regional dealmakers often find the need to explain to investors from common law countries the differences between the trust and the fideicomiso. Probably the main difference is that while the idea of dual ownership (legal and equitable) is of the essence of the trust, it is foreign to the fideicomiso. In the trust, legal ownership (trustee) and equitable ownership (beneficiary) are concurrent and often co-extensive; in the fideicomiso, the ownership of the beneficiary begins when the contractual agreement comes to an end and the trustee no longer administers the assets. The beneficiary is only a creditor of the fideicomiso and not the equitable owner of the estate. Its “bankruptcy remote” nature makes the fideicomiso a suitable way to guarantee that the resources needed to fulfill an obligation will be kept aside. The Peruvian national government established a fideicomiso to guarantee that the monetary resources to pay for the expropriation of the land needed to carry out the second phase of the expansion of Lima’s international
Large-scale initiatives such as the expansion of the gas transportation capacity in Argentina, the Bogotá-Girardot highway in Colombia and the financing of operations of several Peruvian airports are examples of works that are using the fideicomiso. 13
Infrastructure airport would be there when needed. Since the international consortium operating the airport had to raise the money for the expansion works in the international capital markets the certainty given by the fideicomiso was of critical importance to a successful fundraising. Furthermore, this same trust guarantees the regularity of the payments by the public sector to the private parties that were granted the “co-financed concessions” of several provincial airports. The expansion of the Bogotá-Girardot highway is without a doubt one of the most important works in the history of ground transportation in Colombia. The consortium that was granted the concession of the project transferred all the economic rights originated in said concession to a fideicomiso administered by a specialized financial services institution. One of the purposes of isolating these rights was to provide credit support for the asset backed securities issued by the same trust and sold in the capital markets to investors. The bonds issued by “Fideicomiso Concesión Autopista Bogotá – Girardot S.A” were rated Triple A and Double A. A fideicomiso can also be used as the SPV of a project. In this case, project sponsors transfer all the project assets to the trust and constitute themselves as beneficiaries of it. The trustee has a mandate to both administer the assets and enter into the contractual relations typical of a project finance structure. Possibly the largest construction company in Latin America, the Brazilian “Construtora Norberto Odebrecht S.A”, was hired to install 1700km of gas pipelines that will run from north to south in Argentine territory. This massive project, valued in billions of dollars, has a fideicomiso in the centre of all contractual and financial relationships. So, for example, while Odebrecht signed an EPC (Engineering, Procurement & Construction) contract with the winners of the project’s public tender, the rights and duties emerging from the contract were immediately assigned to the fideicomiso, making it Odebrecht’s new client. A seasoned dealmaker at the Inter American Development Bank told us that the fideicomiso has evolved from a purely technical contract to a more comprehensive one that regulates every aspect of the deal from the circulation of cash flows to the way parties communicate amongst each other. This source mentioned that the way the contract is currently being drafted provides an appropriate framework for parties to negotiate their way out of conflicts and avoid lengthy arbitration procedures that may hinder the development of a project. The regulation of the Latin American Trust has been crucial in the structuring of infrastructure development projects particularly in the transportation and energy sectors all across the region. The case studies analyzed show how much governments and private sector financial and strategic investors value the fideicomiso’s versatility and solidity. It is encouraging to see other countries in the region, such as Costa Rica, looking to consolidate the Latin American Trust as a way to move forward with infrastructure works.
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Infrastructure
Patricio Abal holds a J.D. from the Universidad Cat贸lica Argentina and is a Master in Project Evaluation Candidate at UCEMA & ITBA in Buenos Aires, Argentina. He has worked at an Argentine law firm, the United States Senate, and at an Argentine venture capital firm.
Gonzalo Oliva-Beltr谩n holds a J.D. from the Universidad Cat贸lica Argentina and an LLM from the University of Westminster. He is a senior associate at Rattagan Macchiavello Arocena & Pe帽a Robirosa, in Argentina.
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Emerging Markets
A New Era for Investment in Argentina ██ By Javier Canosa
A
fter the fall of Lehman Brothers and the crash of the stock market in 2008, Latin American countries have managed to live through and survive the world crisis very much unscathed. Although the majority of the Latin American countries have endured the crisis, in the rest of the world, its effects have carried on through 2009 to affect not only the financial markets, but also the real economy.
“May you live in interesting times” Ancient Chinese Proverb
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Emerging Markets In 2010, the crisis in Europe has spread out around the globe and yet again, Latin American countries are alive and kicking. In the first quarter of 2010 Brazil grew at a staggering 9% rate as compared to 2009; whilst Argentina grew at more modest 8.1% rate in the same period2. In April 2010, Argentina had an historic record of income tax collection. In this same venue, Merrill Lynch has recently increased its growth rates both for Argentina and Brazil, (Brazil from 5.3% to 6.0% and Argentina from 2.2% to 4.8%)3. In line with this, the majority of the analysts argue that in the next decade Latin America will lead the world’s growth. Argentina, however, has not yet fully convinced investors. There are still things to resolve in Argentina; in general the business environment needs more predictability and clearer rules for the businesses. Other issues that need to be taken care of in the short term are the termination of the procedure with the hold-outs, the control imposed by the government over the statistics bureau and the control of the inflation. In spite of this, we are seeing that investors are preparing the field for 2011 or 2012 when the prospects are clearer. This article will analyze the evolution of investments in Latin America, with special emphasis on Argentina, then describe the current investment mood and structures chosen by some investment entities and finally define some sectors that have particularly interested foreign investors.
██ A new period? The current crisis in Europe and the United States has made investors look deeper into countries that were considered riskier in the past, such as Brazil, Chile, Mexico and to some extent, Argentina. This is of course a new period. How do we define this new mood or trend and what characteristics make it unique as compared to other investment periods? Let us begin by defining and analyzing the past investment periods to asses the current trend. In the first period, foreign investment came exclusively in the form of foreign direct investment lead by large multinational companies with operations all around the globe. These were companies that were just transplanting their business philoso-
phy and know-how into the Latin American countries. These companies were investing with the same brand and structure as in their relevant home jurisdiction and were controlling 100% of the corporate capital in the local companies. In the period from 1991 to 1994 private equity funds came about. These funds were originally foreign. With state deregulation, privatization and familiar companies in need of cash, many private equity funds looked into Argentina as a target for their investments. In this period, private equity firms concentrated on companies with good cash flows and were basically focused on sectors such as telecommunications, transport, cable tv, financial services and retail. It this time Argentina was the second largest rLatin American ecipient of private equity capital. Between 1995 and 1998 the free market model was widely accepted in Argentina and private equity deals came about as customary run-of-the-mill transactions. In this era, many regional (and local) private equity funds were created. Between 1999 and 2001 was the period of Venture Capital funds. In this period private equity funds were less interested in Latin America because of the Asian crisis and the devaluation of the Brazilian real. However, Venture Capital funds emerged as a new way to finance projects. New companies were created and Argentina became a part of the internet bubble. Venture Capital firms invested in innovative companies developing new technologies. In this phase, 20% of the investments were directed to internet projects in their first steps of developments. Between 2001 and 2005 there was almost no foreign investment in Argentina. However, some local funds were created and were actively involved in the energy sector, basically acquiring the assets left behind by funds or companies from Europe and North America. We are now slowly experiencing the commencement of a new era. This period has some traits of the past and some particular new features. It is not yet defined as companies and funds are aiming to 2012 after the presidential elections in Argentina. Firstly, it is worth mentioning that this new form of investment is somewhat opportunistic, because it is looking for large profits, but at the same time also very patient and looking into the long
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Emerging Markets run. Let us define some of the sectors specifically considered by this dormant and embryonic new investment wave.
██ Some interesting sectors Whilst some investors, be it individuals, private equity funds, familiar funds, or just investment companies, have already seized opportunities in Argentina. Examples include such cases as agriculture, lithium mines, gold, or real estate; some investors are merely approaching the sectors, analyzing and studying the target.
██ Agriculture
It is also expected that increases on utility fees be authorized in the not so distant future. Just to give an idea on how depreciated the current structure is, $100 USD in electricity in the City of Buenos Aires cost $985.63 USD in the city of Montevideo, Uruguay, $744.49 USD in Sao Paulo, Brazil, and $790.89 USD in Santiago, Chile. This is being studied and analyzed by a few large funds and companies.
██ Lithium Some minerals have also drawn up a lot of attention in Argentina, notably, the case of lithium. With an increasing long-term demand for oil, the search for energy conservation has increasingly been aimed at lithium, the key resource needed for the manufacture of energy-efficient ion batteries powering hybrid cars.
The first sector that comes to mind and that grew at Chinese Demand for lithium carbonate doubled from 2003 to 2007, and rates (most likely due to the Chinese growth) is the agriculture a report by Credit Suisse states that the market for lithium-ion sector. In spite of an incredible tax on exports (withholding) batteries may expand to 14 times its of 35%, the agricultural sector has 2009 size by 2030. Lithium is typically steadily grown since 2005, both in recovered from high-altitude desert arland prices and yields per hectare. eas, chiefly in the Andes Mountains, with The price of the queen of crops After major complaints from roughly 80 percent of the world’s known (soybean) has more than doubled the operating companies, lithium reserves found in Argentina, since 2002 reaching its peak just Bolivia, or Chile. before the fall of Lehman Brothers. including some companies Prices of farm land have increased at similar rates, while crop yields have not grown as much, basically because of the above mentioned export withholding currently set at a 35% rate.
that had to fire-sell their assets in Argentina, in 2009 the State agreed to subsidize part of these fees to the operating companies.
In the case of agriculture, we see two types of investors, (i) farming funds and farming companies looking for a long term business and (ii) speculators looking for another increase in these commodity prices and the reduction (or annulment) of the export tax after the elections in 2011. The votes of the farmers will be necessary for anyone with an aspiration for winning the presidential election in 2011, therefore any such candidates will have to include a reduction or annulment on the withholding on farming commodity exports.
██ Public Utilities Another interesting sector, for the large institutional investor, is the public utilities sector. Utilities fees have been frozen approximately since the end of the termination of the convertibility between the peso and the dollar in the end of 2001. After major complaints from the operating companies, including some companies that had to fire-sell their assets in Argentina, in 2009 the State agreed to subsidize part of these fees to the operating companies.
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Seeing how Argentina is the largest producer of lithium and holds one of the largest reserves in the world, the interest in this mineral has grown exponentially. One hectare of lithium potential property could be bought at $100 USD in 2008; currently that same hectare of lithium potential property can be bought at $5,000 USD.
In this sector, there all kinds of investors. Some are speculators that obtained good profits in a relatively short period of time while other investors are looking at the long run, such as Toyota who has recently invested $100 million USD in a lithium project in Salta, Argentina4.
██ Real Estate Real Estate is another market that has grown exponentially since 2002. Its growth can be explained in part due to commodity prices (agricultural profits) and indirectly due to the Chinese demand. What is striking about the Argentine real estate market is that it has grown with no credit and no leverage. In 2009, only 5.2% of the transactions involved some type of credit for the purchase. In the graph that follows, the green arrow depicts the growth of building in square meters and the blue arrow depicts the average price per square meter.
Emerging Markets
In this sector, there are investors of all sorts: individuals willing to diversify their assets without running large risks, speculators, large funds, familiar funds - in short, investors from all walks of life. We would not call this boom a bubble as it is not fuelled by credit, but by genuine and real investment. Also, the current lease prices provide for a return of investment between 4% and 15% depending on the asset and the lease, and even without taking into account the appreciation of the assets as such.
██ China Finally, a few words on China and its influence in Latin America. In 2009 Chinese companies were involved in 80% of the major M&A deals in Argentina. China is now the first economic ally of the South American region, primarily due to the Chinese need for raw materials. There are Chinese investors interested in minerals (exploration and exploitation) in Argentina.
Javier Canosa is a Partner at Canosa Abogados, whose practice specialises in corporate law issues, advising several national and foreign companies in various corporate matters, including investment vehicles, corporate management, directors’ duties and responsibilities, audits, risks’ detection and distribution, documents, policies and corporate contracts, and design and implementation of a suitable corporate form for each business. www.canosa.com.ar
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Emerging Markets
20
Mexico
Emerging Markets
Superstar Player of the Emerging Economies
M
██ By Tessa Albrecht exico: Latin America’s newest investment beacon and slightly less-publicised regional superstar. With the highest level of FDI in the region and a more stable political environment than ever before, Mexico is an investment destination prime for the picking and one that is giving its key industrial competitor, China, a run for its money.
It is Latin America’s second largest market after Brazil and is tipped to become one of the largest world economies by 2050. So, what about Mexico’s economic model makes it so alluring to international investment? And what sets it apart from China, a fellow emerging economy and previously recognised as the world’s cost-effective manufacturing hub of choice?
██ Recipe for success Mexico certainly has the right ingredients to wet the appetite of multinationals and investors alike. Perhaps most alluring is the country’s geographic proximity to key trading partners. In a world where time is money, Mexico has a competitive advantage on account of its nearness to its largest customer and neighbour to the North, the United States (US). Mexico receives approximately 75% of its FDI from the US and sends 85% of exports back. Whilst a hike in the cost of oil causes shipping prices to soar and reduces China’s labourcost advantage, Mexico’s location remains attractive. It offers its target market a shorter logistics network, perfectly suited to products requiring quick time to market. Similarly, the positive dollar-peso relationship has a role to play in this story. The Calderon Administration’s tightening of fiscal and monetary policy over the past three years has seen the peso become less susceptible to global fluctuations and remain at a low enough level to be advantageous to trade relations. In comparison, China continues to receive scorn from the US for
maintaining its currency at ‘artificially’ low levels. Naturally, the strained dollar-Yuan relationship heightens the attractiveness of the peso as the currency of choice. Mexico’s strength is also attributable to its implementation of numerous Free Trade Agreements (FTAs). The North American Free Trade Agreement (NAFTA) certainly speaks loudly: there are certainly advantages associated with being part of the largest trading bloc in the world. According to the Embassy of the United States in Mexico, US goods imports have grown 223% since NAFTA’s implementation, and Mexican exports to the US have increased by 396%. More than 90% of Mexican trade is under FTAs with more than 40 countries (although interestingly enough, not with China). Powerful political allies also enhance beneficial terms of trade. The political relationship between Mexico and the US is positively blooming, with Obama and Calderon recently re-affirming their strategic partnership through a Joint Statement in May. Both are members of key international bodies and identify on account of shared values of democracy, self-determination and human rights.
██ If you can’t beat ‘em, join ‘em Mexico’s popularity is such that it is even attracting the business of its biggest rival. China is Mexico’s second largest trading partner and accounts for just under 10% of Mexico’s exports and imports. China’s co-operation across the southern hemisphere is multi-faceted; it has recently sought donor member-
21
Emerging Markets Still, the energy sector remains slightly teasing. The potential for oil and mineral exploration continues to whet the appetite of investors, who can likely taste the ROI potential just beyond the ultimate barrier to entry: state ownership.
ship in the Inter-American Development Bank, and it released its first official policy paper on China and Latin America. Perhaps most poignant in China’s dealings with Mexico is its engagement of local staff. China has eagerly affianced Mexican workers for training and development purposes. Evidently, the creation of a skill-based economy is in Mexico’s long-term interest and will assist it in progressing to the next stage of economic development. Take, for example, Mexico’s strong automotive industry: local workers are engaged to produce technologically complex components and engage in Research and Development activities far beyond simply assembling a car.
██ Forward Thinking What is unique about Mexico’s economic approach is that it’s confident of its future direction and appears to be wise beyond its ‘emerging market’ label. Mexico’s economic potential extends far beyond the short-term gains associated with the typical ‘manufacturing prowess’ of a developing country. Highly self-aware, Mexico’s growth strategy is strategic and purposeful: while its strongest industries are manufacturing, autoprocessing and energy, the country is focused on developing sectors typically reserved for more mature economies, such as financial services, medicine and pharmaceuticals. Government policy has been instrumental in opening up these industries to foreign investors. Through the Foreign Investment Law of 1993 and also on account of NAFTA, foreign investors can now participate in financial services. International investment banks have poached the Mexican market heavily in the past few years, creating a strong increase in product offerings for locals.
22
But where there is a will, there’s a way. In recent years varying degrees of international investment into government owned sectors has been made possible through the ability to participate via “neutral investment” structures as approved by the National Foreign Investment Commissions1. Mexico’s natural resources are certainly one of its more attractive features; and as long as nations like the US and China are addicted to the black gold, Mexico’s prospects are almost limitless. Mexico could also provide the US with a nice opportunity to reduce its oil dependency on the Middle East. The transport sector also has potential, although Mexico’s promotion of this sector for investment has been rather lacklustre. The country’s diverse terrain coupled with previous economic shortfalls means that it lacks an integrated transportation network that can meet the needs of a large, mobility-seeking population or the requirement for speedy transport of freight. Mexico’s close proximity to key trading partners suggests that improvements to its Just-in-Time (JIT) competitive advantage may be further realised through expediting domestic travel times. The main railway network, The National Railway of Mexico, was privatized in 1997 and should provide a starting point for investors.
██ Rough Seas Ahead? Mexico is well positioned for success but that doesn’t mean it will all be smooth sailing. Like China, Mexico is a newly industrialised nation that is experiencing many of the common ‘teething’ problems and growing pains associated with economic development. In order to reach its true potential, Mexico must overcome some rather large challenges. Mexico suffers from a commercial overdependence on the US. Mexico has sought deeper ties with Europe; however relevant FTAs have so far failed to reduce economic reliance on its northern neighbour. The high level of violence and organised crime in Mexico also threaten to undermine investor confidence. Despite Calderon’s
Emerging Markets crackdown on drug-trafficking, cartel battles have increased and drug-related deaths doubled to more than 6,000 between 2008 and 2009.2 It is a sure-fire investor-repellent – the country’s Finance Ministry estimates that violence reduces growth by 1 percent per year3 – and as such, the eradication of such activity should be a key policy objective. Yet crime also presents an opportunity for those in the private security industry. Where there is a lack of confidence in local authorities, alliances between the private and public sectors may be a country’s best bet to reduce violence in the short term. A cheap Peso may be beneficial to trade in the short-term; however Mexico needs to ensure that its high level of emigration to the US (and a better salary) doesn’t reduce the benefit. Labour market reform has been called out as a key issue for years. In 2005, around 400,000 Mexicans moved north over the border. Comparatively, while China seems to experience rapid population movement within its borders and from rural areas to cities, its emigration across the border is not as extreme as Mexico’s. The government will need to place more emphasis on education, training, and wage reform to avoid high levels of emigration and the accompanying ‘brain drain’ and capital flight. Labour market reform may also better shape the development of a middle class and encourage local buying power.
██ A star in the making Mexico is certainly a star in the making and correctly poised to become a top economy by 2050. It is slipping confidently across what China previously thought was its world stage, and it certainly knows how to use its strategic advantages to attract even its largest competitor. Mexico is making a number of in-roads across a range of economic sectors, showing potential for long-term success. With careful management of the key challenges mentioned, Mexico’s transition from promising emerging economy to fully-fledged economic superstar is certainly possible. Tessa Albrecht is a Sydney-based Risk Analyst at a leading Australian bank. Tessa holds a degree in International Relations from Bond University, with majors in Spanish and International Business, and previously held the position of Business Development and Marketing Manager at the Spanish Official Chamber of Commerce. Fluent in Spanish, Tessa has a keen interest in Latin America, emerging markets and alternative investment
23
Cuba
Emerging Markets
Return to Capitalism? ██ By: Vonnell I. Martinez
T 24
he day is coming when not another Cuban will risk drowning in a desperate attempt to cross the Florida straits while searching for freedom from the asphyxiating grip of a regime whose only achievement has been the vicious oppression of its people—A system and leader bizarrely respected and even loved by many around the world who naturally have never lived as much as one minute inside communist walls.
Emerging Markets
The irony is that even Cuba’s self-claimed leader recognizes the pristine potential of capitalism. What, then, has kept Fidel Castro stubbornly insistent on this regime for so long? Two things come to mind: fear and the stealthiest, strongest force in the universe, more so than compounding interest—political ambition. Before the Cuban Revolution on January 1, 1959, Cuba was a capitalist society with living standards considered high by many developing and developed nations (even under Batista, another murderer in power by coup d’état). One of the best questions ever asked, “Are you better off now than you were four years ago?”would suit Cuba excellently today. If the Cuban government asked its people (without the threat of imprisonment), “Are you better off now than you were 51 years ago?” the “NO” would be so resounding that the entire island would probably
snap in half. What is different? Until 1959, free market was the norm. Since then, whimsical soldiers have ruled the country and planned its economy. Following the collapse of the USSR, Cuba’s leaders were no longer able to freeload as a satellite of the Soviet Union. With their pimps turned to corpses by common sense, they needed a way to survive while they found the next hand that was to feed them (now mostly Venezuela, led by Fidel’s main vulgar and illiterate puppet, Hugo Chavez). But what could be strong enough to stop Cuba from decaying in free-fall? Cuba named this post-Soviet period the “Special Period.”I agree. But what was so“special”about it? The Cuban government had to ask for help from the system it constantly attacked: capitalism.
One of the best questions ever asked: “Are you better off now than you were four years ago?” would suit Cuba excellently today. 25
Emerging Markets
In 1993, left to his own devices and with no one to mooch from, Castro added himself to the list of those who, despite their tantrums, have validated capitalism’s prosperity (China is another excellent example). For the first time in the Communist Cuba’s history, Cubans were allowed to set up private businesses. This decision, especially in this delicate period, was Castro’s confession that he too knows capitalism to be the only source of power to raise living standards—that no politician or revolution will ever do more for men than their own free will. Cuba imports around 80% of its food, most of which comes from the United States. Alabama currently trades with the island, although not allowed to purchase Cuba’s goods. Moreover, for more than a decade, there has been plenty of indirect American capital entering the island by means of Canadian and European multinationals that count on American investors as their shareholders. Yet Fidel continues to fill Cuban ears with anti-imperialist nonsense. Irony or hypocrisy? Answer: Castro thanked his lucky star when he found Chavez, but the message is nonetheless loud and clear: Fidel Castro is a closet capitalist. Estimates show an additional $20 billion-plus in direct capital entering the island once Cuba rids itself of its Stalinist-like cancer. And 11 million people on the island (the entire population), millions of exiled Cubans and thousands in Castro’s own government (including his right hand—his brother), also impatiently wait. Castro knows Marx’s theory linking capitalism and communism is true. However, he also knows that one of the many things Marxism got wrong was its direction: Communism collapses under its own stagnation, eventually leading to capitalism. Surprising? No. This is the real world with real people; Marx was no more than a fairy-tale theorist. And herein lies Cuba’s postCastro potential. After Mussolini, Franco and Hitler, people shifted far in the opposite direction—a little too much perhaps, for which they are paying the price today, turning Europe into a collection of welfare states. Arguably, America’s influence prevented the full shift into communism’s abyss. (Post-Batista Cuba wasn’t so lucky.) Like Europe, Cuba can shift its system, but in the opposite direction: moving far away from communism, thus becoming a solid democracy and free market society—more so even than the soon quasi-socialist United States. Nothing stays the same forever. Cubans will one day be able to shape their future based solely on the results of their own efforts and the guidance of their own minds. Cubans will be free to buy and produce whatever they desire and vote for whomever they choose: democracy. Cubans will have the option to implement a system based on the recognition of individual rights, in which property is privately owned and the use of physical force is prohibited: capitalism. Contrary to guns and coercion, what
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better system can exist in which every man and woman has the freedom to rise as far as he or she is willing and able, and all human relationships are voluntary? , private equity investments and real estate. Vonnell I. Martinez Founder and CEO of VIM Resources LLC. Finance graduate from University of Miami’s School of Business with a deep passion for investments and financial efficiency. VIM Resources LLC - www.VIMResourcesLLC.com An investment and fiscal consulting firm headquartered in Miami, FL with operations and expansions in New York, Los Angeles, Italy and Brazil. Senior management consists of analysts, economists, consultants, statisticians and a full real estate team with more than three decades of combined experience. Investments are focused on U.S. and international businesses, consisting of selected hedge fund techniques, private equity investments and real estate.
Emerging Markets
27
Funds
Merlin Securities’ Best Practices for Latin American Fund Managers ██ By Ron Suber
Over the past decade, several factors have converged to make Latin America one of the most exciting regions for hedge fund managers and investors. These factors include a large and growing population of high-net-worth and institutional investors, increasingly talented managers and an influx of foreign investors seeking geographic diversification. As the size of the market has grown, so too has its level of sophistication. Just as U.S., Asian and European investors have come to demand greater levels of operational and investment excellence, Latin American investors also now expect to receive the same standards. This includes institutional quality risk management, compliance, execution and a clear, repeatable and consistent investment methodology, among other things. Merlin Securities, who earlier this year established its Latin American presence and tapped Victor Hugo Rodriguez as its newest partner and head of Latin American sales, offers two papers to help both investors and managers achieve institutional quality.
██ The Big 12: Merlin’s Best Practices For Hedge Funds Managers who meet these Big 12 Best Practices and generate Alpha can seize the growth opportunities in the marketplace. 1.
Written compliance and employee trading policies with periodic attestation
2.
Multiple levels of authority on cash movements with a minimum of two people controlling input, release and approvals
3.
Written and consistent valuation policy by asset class
4.
Sound technology and infrastructure with reliable back-up, disaster recovery and business continuity plan
5.
Open architecture to handle multiple prime brokers, multiple custodians and managed accounts
6.
An understanding of why these firms are used and the alpha they generate
7.
Clear risk management methodology
8.
Ability to prove best execution
9.
High-quality audit, tax and legal representation
10.
Sustainable third party administration with SAS 70 Type II
11.
Dedicated operations manager, COO, CFO and CCO
12.
Significant principal’s money in the fund
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Funds
Merlin’s Four Quantitative and Three Qualitative Minimums For Hedge Funds ██ The 4 Quantitative Minimums: 1. Articulation of your Alpha and Beta vs. your custom benchmark. Investors separate Alpha and Beta performance and allocate differently to it — they pay for Alpha and demand accurate measurement of it. 2. Detailed asset allocation versus stock selection analytics (relative attribution). 3. Intra-month exposure (as opposed to end-of-month snapshot) and exposure over time for custom and flexible periods. 4. Risk: not only must you mitigate and control for it, and articulate the traditional measurements, but you also must be able to take deeper dives into unintended risk — tail and hedging risk and more.
██ The 3 Qualitative Minimums: 1. Very clearly differentiated business. This means that you must: • •
Articulate your edge and process. Make your explanation of how you excel memorable, easy to follow and easy to understand. Remember, impressed but confused investors do not invest.
And your Pitch Book must immediately get right to: • • •
Who you are. What you are doing. How you get there.
2. You need the capital, talent, commitment and staying power to persevere. Once you get to the inflection point on the hockey stick you must scale without creating too much burden on your investors. 3. Managers must accept and tolerate deeper dives and requests for greater transparency from investors. Some will require a Board of Directors with an agenda and minutes. You will face more frequent and more customized requests for information from investors. Funds that can meet these requirements will have an exciting opportunity to pull away from the pack.
Ron Suber, Senior Partner, Head of Global Sales and Marketing Prior to joining Merlin Securities, Ron was President of Spectrum Global Fund Administration. He worked at Bear Stearns from 1992 to 2006 where he was a Senior Managing Director and the Manager of Global Clearing Sales for the Prime Brokerage, Correspondent Clearing & Registered Investment Advisor businesses. He holds a B.A. in economics from the University of California at Berkeley. Mr. Suber is a founding member of the West Coast executive committee of Hedge Funds Care and now serves on the National Board of Directors Founded in 2004, Merlin is a leading prime brokerage services and technology provider for hedge funds and managed account platforms around the globe. The firm serves more than 450 single- and multi-primed managers, providing them with a broad suite of solutions including dynamic performance attribution analytics, risk reporting, seamless multi-custody services, capital development, 24-hour international trading and advanced securities lending consulting. Please visit www.merlinsecurities.com
29
Art
Christie’s Latin Art Sale Breaks $20 Million
W
ith the world slowly crawling out of the crisis depths, there has been an ignited interest in Latin American fine art investment seen by this year’s Latin Art Sale at Christie’s New York. The sale totaled over $20 million dollars, greatly surpassing last year’s totals. ALI had a chance to speak exclusively with Virgilio Garza, the head of Latin American art sales at Christie’s New York. In the following interview he gives insight to the potential reasons for the sudden turn around.
How is the general art market faring post crisis - i.e - sales of other auctions, buyer participation/attendance? For the Latin American market – last year was a good year however very interesting in terms of how it developed. Last May we weren’t sure how we were going to do, we did ok, then in November we did better, then this sale (May) was really strong. It (Latin American art sales) had been escalating steadily and solidly up until the financial crisis of 2008, I think there is a lot of renovated energy in the market, also there’s a desire for important works of art. The most important works are getting the best prices and selling really well, there is a desire to buy prime works in the field – works that haven’t been on the market for many years, that are significant in the artist’s career. For example the Mexican works we offered this last sale had been in the family for two generations, when something like that happens the market responds. How does the Latin American art sector compare (in regards to sales and growth)with other art sectors - Asian, Middle Eastern, Native American, Fine art? All I can say is that the sales in May have been very successful. We started with a bang with impressionist and modern sales – the numbers are really impressive, the Picasso sold for over $100 million – those price structures are very remote from ours, but never the less – we do get a lot of cross over sales. Collectors that are active in impressionist or post war also buy with us (Latin American Art Sector) so the success trickles down to us. Beatriz Milhazes – one of the most successful living Brazilian artists – we sold her work for over half a million dollars. We have had some Asian participation as buyers. Also, some of our Mexican collectors buy impressionist and post war – the market is much more global now.
30
ALI’s last two articles featured Cuba and Brazil - according to your expertise, what are the big Latin American regions to watch? Mexico is always a key player, Brazil of course, particularly in the modern and contemporary works. Some of the works of Argentine artists have been revisited. There are major artists like Soto who passed away, however was very big in the 70’s, and is now having a major revival of this work.
Virgilio Garza From an investment point of view would you say Latin American Art is more volatile compared to other sectors? That is to say, for example, will a Picasso or other fine art experience smaller changes in value as they are more established? I would say that the opposite is true. Our market is not a market of high speculation – Picasso is Picasso, there is no speculation there, he is the greatest artist that ever lived and I think there is an agreement around that, and that market is rock solid. Particularly with very contemporary works there are highs and lows. With us (Latin American art) we are a very steady market. It’s a market of slow steady growth, and we haven’t had major shifts in volume and totals. There are always fluctua-
Art
Purchase Price
Lot
Description
Estimate ($)
27
Frida Kahlo, Survivor, oil on metal framed by artist in a handcrafted Oaxacan tin frame, painted in 1938
100,000150,000
$1,178,500 £824,950 €966,370
Private
José Clemente Orozco, The City, oil on canvas, painted in 1929 WORLD AUCTION RECORD FOR THE ARTIST
200,000300,000
$1,142,500 £799,750 €936,850
Private
Fernando Botero, Woman on a Horse, bronze with dark brown patina, executed in 2002
800,000-1,200,000
Joaquín Torres García, Composición constructiva en planos y figures, oil on canvas, painted in 1931
800,000-1,200,000
$1,046,500 £732,550 €858,130 $866,500 £606,550 €710,530
Rufino Tamayo, Figura de pie, oil and sand on canvas, painted in 1959
450,000650,000
$818,500 £572,950 €671,170
North American Private
Jesús Rafael Soto, Un Trou sur l’Orange, painted wood, nylon and metal relief on wood panel, executed in 1970
250,000350,000
$758,500 £530,950 €621,970
South American Private
50
Rufino Tamayo, Danzantes, oil and sand on canvas, painted in 1963
500,000700,000
$746,500 £522,550 €612,130
South American Private
69
Sérgio de Camargo, Relief No. 188, painted wood relief, executed in Paris in 1967
500,000700,000
Beatriz Milhazes, 578, oil and acrylic on canvas, painted in 1994
250,000350,000
$626,500 £438,550 €513,730 $506,500 £354,550 €415,330
Fernando Botero, Society Lady, oil on canvas, painted in 1995
350,000450,000
54
56 40
51
44
77
61
$470,500 £329,350 €385,810
Buyer
Asian Private Private
Anonymous South American Private
European Private
31
Art tions and variations but the Latin American art is not a market of high turnover. The collectors who buy works in our sales tend to keep them for a long time, which is challenging for us to organize auctions, as the important works tend to stay in families for generations. There’s not much flipping of works – something that may happen in more speculative markets.
has been a whole new young generation in Puerto Rico. They all tend to eventually converge in New York in one way or another in the end.
Were you surprised by any particular sales in 2010? Pieces, artists, styles, etc?
We are a great value – the prices that you see in other categories are spectacular, however the possibility to build a great collection with a relatively small amount of money is very real in our field. If you have a million dollars you can find great things to buy in our sale – your money will buy you amazing things, the beginning of a great collection – you get more for your money.
I as a spectator and employee of Christies was very excited by the Impressionist sale in terms of what was offered. It was the sale of the season. The collections that they gathered were of high importance. I’m also thrilled with our Latin American sales – some of the Mexican works that we found are very exciting for us – the works of Orozco, the Tamayos, the record for Jesus Rafael Soto is very important to me. It is one of the greatest Soto works that has ever been sold on auction and the market responded accordingly (in May’s auction, world records were set for twelve artists, most notably for Jesús Rafael Soto’s multi-dimensional t Trou sur l’Orange, 1970, which sold for $758,500). We were successful in selling a monumental sculpture by Botero there was a small Frida Kahlo that we rediscovered did incredibly well. (see fig 2) Survivor, 1938 by Frida Kahlo, the palm-sized painting — which hasn’t been exhibited since 1938 — went for $1,178,500 ten-times the low estimate of $100,000-$150,00 Have you seen greater participation in Latin American art buying from any specific geographic group, ie - growth in European, Asian, Middle Eastern buyers? American collectors play a major role in our sales – there are definitely Latin American residents as well, roughly 40% US, 40% LatAm, 20% rest of the world As wealth increases in Latin America have you seen an increase in purchases in art in general by Latin buyers? The increase in wealth is affecting the investment environment – Latin American residents seek information and remain educated, thus building informed collections and collecting as a life style. A lot of Latin American residents buy other types of art as well, watches, wine, contemporary art, etc… Is Christie’s looking to increase their involvement with Latin American art, ie hold more auctions, etc? Christie’s is committed to two sales per year – next sale in November – we are VERY competitive with a 55% market share against our competitors and are definitely the market leaders. Would you say there is an ‘epicenter ‘ of Latin Art, that is to say what is the New York or Paris of Latin America? Latin America means many things in terms of art – there are many centers, São Paulo, Buenos Aires, Mexico City – there
32
In your opinion, what makes the Latin American art sector unique and desirable from an investment perspective?
After evaluating Christie’s most recent sale, ALI determined that the art was undervalued by 34% on average (sum of all art shown, 8.1million USD - sum of top range estimates, 6.05million USD = undervaluation of 34.8%) One specific example of this would be Frida Kahlo’s “Survivor” which was listed at 150K and sold for over a million. In response to this, Mr. Garza gave the following commentary: “Estimates are based on a number of factors, including the quality of the work, past auction prices and demand in the market for the particular artist’s work. When works exceed our estimates, it proves the vigor in the marketplace and that buyers are eager to acquire works of utmost quality and provenance.” Frida Kahlo, Survivor, oil on metal framed by artist in a handcrafted Oaxacan tin frame, painted in 1938 - $100,000-150,000 Sale Price $1,178,500
Art José Clemente Orozco, The City, oil on canvas, painted in 1929 WORLD AUCTION RECORD FOR THE ARTIST $200,000-300,000 Sale Price $1,142,500
33
Art
Fernando Botero, Woman on a Horse, bronze with dark brown patina, executed in 2002 $800,000-1,200,000 Sale Price $1,046,500
Rufino Tamayo, Figura de pie, oil and sand on canvas, painted in 1959 $450,000-650,000 Sale Price $818,500 .
Joaquín Torres García, Composición constructiva en planos y figures, oil on canvas, painted in 1931 $800,000-1,200,000 Sale Price $866,500
34
Commodities
Chinese Brazilian Trade Ties
Continue to Grow ██ Bernard Lapointe
I
n April, China and Brazil signed various trade agreements with the objective of boosting two-way trade between the two countries. In particular Presidents Hu and Da Silva signed a 5-year action plan to increase trade and energy cooperation.
35
Commodities
Since China joined the World Trade Organization (WTO) in 2002, Brazil’s exports to China have grown at 23% per annum, faster than during the 1989-2009 period at 18%. Brazilian imports from China have grown at 26% per annum since 1989. Recently China overtook the USA to become Brazil’s number one trading partner. As of May 2010 exports to China accounted for 14% of its total exports, from 4% in 2002. Imports from China, the world’s largest goods exporter, represented 13% of its total imports versus around 3% in 2002. Table 1. CAGR of trade between Brazil and China.
Brazil Exports To China
Brazil ImportsFrom China
2002-2009
23%
26%
1989-2009
18%
26%
CAGR: Compounded Aggregate Growth Rate Source: Secretaria De Comercio Exterior, Brazil
Table 2. Trade between China and Brazil, in value.
In US$, millions
Brazil ExportsTo China
Brazil Imports From China
1989
628
128
2002 2009
2,521 20,191
1,554 15,911
Source: Secretaria De Comercio Exterior, Brazil Just from looking at these numbers it is difficult to determine causality: is the fact that by joining the WTO, China has had any significant impact on trade between the two countries? Or is this just growth-driven? More probably, simultaneous events are responsible for the surge in the amount of trade between the two. Theory suggests that trade liberalization induced by tariff reductions has a positive impact on trade between two countries. Lee and Shin1 confirmed that Regional Trade Agreements (RTA) increase bilateral trade between members. Although in this case China and Brazil are not in a RTA, it is somewhat comparable because the identity of products traded between the two is historically the same. Over 85% of Brazil’s total merchandise exports to China are fuels and mineral products and agricultural products. About 95% of its imports are manufactured goods. During the global expansion of the past decade, the net impact of trade on employment and poverty in Brazil was positive but modest, according to research from the Carnegie Endowment for International Peace2. However it is quite likely that as the value of trade reaches a critical level, gains created in part by economies of scale and the multiplier effect will spread out to a larger share of the population. In the long term, Brazilian export growth to China should sustain the pace of the past few years as it is obvious that the Asian giant is on sound footing. Chinese wages have started rising and will probably outpace the economy’s top line growth. This trend should bear rich secular fruits in the long-term by boosting consumption and accelerating industrial upgrades.
36
Commodities Table 3. Recent Chinese economic data. May 2010, y/y,%
April 2010, y/y, %
Industrial Production
16.5
17.8
Retail Sales
18.7
18.5
Real Estate Investment
38.2
36.2
M2 Money Supply
21.0
21.5
Source: Nomura Global Economics The question for Brazilian exporters is this: can they climb up the value added chain? Although exports to China of high-end telecom equipment, integrated circuits, electronic components, chemical and pharmaceutical products have been rising, it is still insignificant on total merchandise exports. In 2008 the WTO warned that the global financial crisis would affect trade flows globally by reducing access to trade financing. It appears however that the fear was misplaced as Chinese exports have already rebounded – up 48% y/y in May. Brazil’s exports to the middle kingdom, already surpassing US$10 billion for 2010 as of May, should make this a record year. In conclusion, recent measures adopted in April by both countries suggest that two-way trade will remain healthy for the next few years. Bernard Lapointe is currently managing director at ArgonautGlobal Capital, a capital advisory firm with a special focus on India and China. Mr. Lapointe spent ten years with Societe d’Analyses Economiques et Financieres, a French-based investment advisor, acting as global equities portfolio manager and co-chief of strategy. Prior to that he was with Bank of America (New York) as an Asian equity trader and Optimum Gestion (Montreal) as an international equities portfolio manager. He has managed portfolios and traded in equities, currencies and commodities on the world’s major exchanges since 1994. Mr. Lapointe holds a Master’s degree in Economics from the University of British Columbia. He speaks French and Mandarin.
37
Wine
FINE WINE INVESTORS THANK LATIN AMERICA FOR A HEALTHY PROFIT
P
██ Charlie Martin
rices for the world’s most famous wines are rocketing, particularly those from the famous French Estates, providing investors with a relatively new and lucrative way of diversifying a portfolio’s asset base.
Only fifteen years ago the Fine Wine Market was still seen as a bit too esoteric for the average investor, more something for the wine enthusiast or connoisseur. Today this perception has rapidly changed and the market for buying and selling the ‘Investment Grade’ wines of France has moved into a sophisticated sphere with trading networks that can accommodate investors at any level, whether the stake is $5000 or $5 million. Question marks still loom over the soundness of the financial markets, and global equities markets remain exceptionally difficult to read. So investing in physical assets such as fine wine, that by its nature has a diminishing supply, feels a safe and logical route to go. This is the rationale for many first timers in the wine market, but ultimately and most importantly we see the market delivering an impressive ROI. Wines from Bordeaux, France lead the investment market for fine wine because they have the history and quality image that carries an international prestige, a key factor that ensures strong and stable demand. Currently the wine investor is benefiting from rapid upward price movements, a phenomena being driven by a set of new consumers who have begun to buy the world’s most expensive wines and deplete stocks quickly;
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it seems new millionaires from Shanghai to São Paolo are entertaining over a glass of fine French wine, handing bottles over as corporate gifts and so on. The demand from this group is increasing at an alarming rate and this is set against the Chateaux’s fixed supply. It is a fact that Latin American businessmen are now happily clinching deals over a glass of Chateau Latour 2000 and the statistics paint the story, for example Brazilian imports of French wine increased 42% between 2005 and 2009. Other data shows this is not a fad: the statistics for wine consumption as a whole show a cultural shift towards wine consumption across all consumer classes: again in the case of Brazil, the consumption of foreign wine increased 36.54% between 1998 to 2009 and in 2009 alone Brazilians drank 18 million litres of ‘Fine Wine,’ source: Brazilian Union of Viniculture (UVIBRA). Argentina, a nation we know to be a big producer of its own wine, still manages to show an increase of imported French wine
Wine of 64% between 2003 and 2007, source: National Institute of Viniculture - Argentina (INV). Elsewhere, according to Martha Patricia González, Executive Director of the Colombian Association of Liquor and Wine (ACODIL) “1.3 million cases (9 litres or 12 bottles) were imported to Colombia in 2009, representing an increase of 21% compared to 2008’s volumes.” Developing economies in Asia are also lapping up the best French wines, being led by a particularly high demand from China. Charlie Martin, Managing Director of First Growth Bordeaux explains the trend: “Many of these new consumers are found in the Latin American region where strong demand from new entrepreneurs in countries such as Brazil are making some wines hard to find
in the more traditional markets and this moves their price up. We no longer have a market based on wine collectors which was something of a niche set-up, we now have a market based on mass international consumption of the finest wines from a relatively small region of France. There’s a cultural shift in wine consumption, over the last decade it has become a more popular beverage in many developing economies and those markets also have a new ability to purchase at the expensive end of the market. For example when our clients are ready to sell their wine investments it is up to us to find them a buyer, and we are now accepting large orders from China, Russia and Latin America.”
Chateau (2005 Vintage)
First price (GBP/cs) June ‘06
Ausone 8500 Lafite Rothschild 3900 Latour 4500 Margaux 4500 Mission Haut Brion 1550 Mouton Rothschild 3500 Palmer 1370 Average annual performance
Price (GBP/cs) May ‘10
Total 4 yr rise
Appx return / Yr
16800 10700 9500 8000 4800 5900 2800
98% 174% 111% 78% 210% 69% 104%
24.50% 43.50% 27.75% 19.50% 52.50% 17.25% 26.00% 30%
Chateau Margaux, Bordeaux, France
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Wine
All this new consumption results in a scarce commodity and aggressive price movements; the statistics table shows the change for different wine case values from a recent ‘Investment Grade’ Bordeaux vintage. Their performance focuses on price movements for seven famous Chateaux, all from Bordeaux and from a spectacular year of quality, what is known as a “Classic” vintage. The year of production is key to the investment performance. It is vital to have the right year on the label because the consumers of this very expensive wine insist on drinking only those wines from the very best years, where the growing conditions for the grapes were perfect. The inconsistent climate in Bordeaux means it
may only deliver two perfect vintages in a decade, so again this limits the supply of the “Investment Grade” wine. 2005 was a perfect growing year so the bottles carry the right level of kudos for a Label Conscious millionaire buyer: in a global context there simply is not enough produced of this one year to satisfy the number of consumers. The prices are shortly being released for the next year that has been deemed a Classic: the 2009 vintage. It enjoyed ideal growing conditions and many investors are looking at it as an excellent opportunity to invest at the En Primeur stage (this is buying “Wine Futures,” when the wines are still maturing in the barrels). Charlie Martin writes a blog about the impending 2009 Bordeaux vintage release at http://bordeauxenprimeurblog. wordpress.com, and explains the market enthusiasm for this unique opportunity: “There is a massive demand for the 2009’s; we have a big waiting list of clients ready to buy in at the first release prices.” And are any of these clients from the South American continent? “Yes, as well as drinking these wines Latin Americans have begun to consider wine as a very real part of their investment portfolios. Our clients are mainly UK based but we also have clients in India and Russia placing decent stakes in the market and this year we saw the Chinese send large buying teams to Bordeaux to invest in the 2009 vintage.”
Charlie Martin graduated with an International Business Degree from Brunel University, England, that included a specialised dissertation in Wine Marketing. This involved researching the processes of wine pricing and packaging in both Bordeaux (France) and Sonoma (California, USA). He has been advising private clients on buying fine wines as part of an investment portfolio for over a decade and is now Managing Director of a successful wine consultancy business (First Growth Bordeaux Limited / www.firstgrowthbordeaux.co.uk based in London, which offers advice to private clients who wish to invest in wine by the case. Contact: charlie@firstgrowthbordeaux.co.uk)
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8 41
Nordeste Invest
Real estate
Coming to Terms With a New Reality ██ By Mark McHugh
D
uring early May, Natal hosted Nordeste Invest, a landmark forum for international investment in Northeast Brazil. Leading real estate investors and developers exchanged views and provided many vital insights into the evolution of this dynamic market. The conference highlighted several far reaching changes in the business environment following the recession, particularly in the tourist sector. While the outlook remains attractive, the focus is moving to residential and commercial real estate investments. Complexity is increasing, with a growing level of investor sophistication and a marketplace that is now demanding more differentiated offerings directed at Brazilian consumers and the rapidly expanding domestic demand. In conclusion many players have yet to adapt their approach and will need to be more innovative to be successful in future.
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Real Estate The Brazilian economy has been one of the most resilient during the continuing global economic turmoil over the last couple of years. Brasil is attracting the serious attention of international investors because of its new found economic prosperity, growth and stability. With the right strategy overseas investors can make excellent returns, which are largely unavailable in their home markets. A prime example of this trend is Sam Zell, the bell-weather investor in international real estate, who is currently increasing his exposure to the Brazilian market. He is raising $500 million for new investments largely in residential and commercial property. Significantly, Brazilians have increased their purchasing power over forty percent in the last five years. This is underpinning a sustainable consumer boom and anticipated buoyant property demand for several years to come.
at some two percent higher than the expected 6.3 percent national average in 2010.
The Northeast region of Brazil is as big as Germany, Britain, Italy and France combined and is broken up into nine states. It is famous for its year round hot tropical climate, spectacular beaches, and rich diverse culture. Traditionally one of the poorest regions in Brazil, it represents about twenty percent of the whole economy and is currently playing catch-up with the rest of the country. According to a recent central bank survey it continues to exhibit even stronger GDP growth than other regions,
At the same time the overall economic fundamentals still make the Brazilian market highly attractive to local and foreign capital alike. However, the nature of investors and their focus is changing. Offsetting the downturn in smaller investment, there is increasing growth in private equity, pension funds and other more sophisticated players. They are all seeking to take advantage of the comparative strength of one of the most favorable BRIC nations and invest in an emerging economic powerhouse.
Even though the real estate investment market in the Northeast has been a hot spot for investors for some years now, it has being subjected to some major structural shifts during this time. Post recession, inward investment flows by smaller international investors are now drying-up. These were previously the foundation of the market and were aimed principally at the tourist segment. They are declining because the Brazilian real has strengthened dramatically against major currencies. The continuing financial crisis, notably in Europe, is exacerbating this trend窶病 situation that is believed to remain for the foreseeable future.
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Real Estate International real estate investment funds (REITs) are increasingly including Brazilian real estate as part of their emerging markets portfolio. Locally, REITS are referred to as “Fundos de Investimento Imobiliário,” and were established in Brasil in 1993, but only since a change in regulation at the end of 2008 has there been much activity. According to the government regulatory body, the Comissão de Valores Mobiliários (CVM), Brazilian REITs had about 3 billion dollars under management at the beginning of 2010. Despite significant advantages and tax breaks for private investors, they are yet to realize their full potential as investment vehicles. The key trend that is currently shaping the real estate market is the growth in domestic consumer demand and the expanding middle class, which has now become the most important engine of Brazilian economic growth. Wealthy Brazilians are replacing international buyers. They come largely from the economic hubs in the South of the country and are buying second homes in the Northeast―the principal tourist destination nationally.
Investors spelled out the criteria that they use to assess the viability of markets and stressed that the market in Northeast Brazil is in competition for capital in a global market place. Nonetheless, it was observed that Brazil scores well at most levels. The first thing investors are seeking is the overall political and economic stability of the market. Over the last eight years of the Lula government, sound fiscal discipline has certainly paid off creating the right conditions for international investment including an inflation rate below five percent. Brazil has avoided a credit crisis, because there has been a relatively low level of debt. The second factor is the economic fundamentals, which drive real estate value―a growing market, an emerging middle class and expanding population are all keys to sustainable activity. These combine with a resource rich export oriented economy, with growing oil production, massive water resources, and the best green energy matrix of any of the large economies. No further evidence is needed of the strength of the economy than the level of foreign direct investments that have been pouring into the country and the fact that the BOVESPA (the Brazilian stock exchange) was the highest performing stock market globally in 2009 with eighty five percent returns in dollar terms. There is even the added bonus of hosting the World Cup in 2014 and the Olympics in 2016, which is currently spurring much necessary infrastructure investment and will eventually help establish Brazil as a key player on the world stage.
The growing population has created a significant housing deficit, to which the government has responded by launching in 2009 the Minha Casa Minha Vida or My Home My Life program, which has the objective to build a million new housing units nationally within three years.
Many of the resort developments being promoted along the spectacular Northeast coastline were initially conceived during the heavy growth years up to 2007 and targeted mainly at Europeans and North Americans. They have now lost their original customer base. The Brazilian real estate sector is only just beginning to wake up to the true challenge that this represents. Some of the more astute developers are starting to adapt their projects and market to domestic consumers. However, the majority appears content to continue with the same old approach to resort development―a combination of beachfront villas, apartments, hotels and golf courses. At Nordeste Invest, investors expressed concern about the growing danger of over-supply in the resort segment. Already there is evidence of a number of projects in difficulty.
Another important conclusion reached by the panelists at Nordeste Invest was that the key to future success will be to provide differentiated propositions and maintain flexibility to adapt to the further changes in the market. As you might expect, for the time being this implies (at minimum) a modified offering and a price point that meets the needs of Brazilian buyers. Further thought must also be given to providing new experiences. An example suggested was the development of a combined family entertainment complex and resort. The ability to innovate was perceived to be the competitive battleground of the future, when it is believed only the best projects will succeed.
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The final point investors analyze is the legal framework and the ease of doing business― although Brazil has a lot to improve in this area, the country is in tune with free enterprise and probably the easiest of the BRICs for international investors to understand. Although in the past some investors were badly supported and wrongly directed. As in all emerging markets, this only emphasizes the importance of finding serious local partners and professionals, and the need to do careful due diligence. The time for licensing and environmental permitting is also a key element, notably for new development and at best is long and drawn out. Moreover, the rules are opaque and can be interpreted at municipality, state and federal level, which is leading to retroactive decisions on licensing― undermining investor confidence. The Minister, who was present at Nordeste
Real Estate Invest, has promised to review legislation and provide greater transparency. Adapting to the new market conditions, most of the more sophisticated investors appear to be turning their attention to the residential and commercial sectors of the market, which benefit substantially from changing demographics and growing consumer trends. For the moment, they are shying away from tourist areas, which seems will only recover in the longer-term. The most important of the new segments is affordable housing. The growing population has created a significant housing deficit, to which the government has responded by launching in 2009 the Minha Casa Minha Vida or My Home My Life program, which has the objective to build a million new housing units nationally within three years. Under the program the federal government is investing twenty five billion reals to provide subsidized loans to middle and lower income homebuyers through the state owned bank Caixa Federal. Developers can expect returns in excess of thirty percent for well managed projects. Following the recession, international investors are now weighing the risk of new greenfield projects. Preference is now heavily in favor of those projects generating some short-term cash flow. Unless the returns are spectacular, it is becoming almost impossible to sell a resort development with a typical 15 to 20% yield five years out. The sort of profits that were available four or five years ago are becoming harder and harder to achieve. The days are gone when cash flow of a major resort development could be financed out of pre-sales and today the relatively high interest rates for local financing are one of the main factors limiting further market expansion.
Other investor focus is in city center residential development, which is directed at the expanding middle class and incentivized by the increasing availability of mortgage finance. Strong consumer demand also creates a need for more shopping centers and malls—only 400 exist, one per 500,000 people countrywide. Moreover, savvy investors are also looking at picking up distressed projects, often badly capitalized or under-funded, which can offer superior returns in shorter time scales. Finally, a key issue affecting the recovery of the tourist sector is accessibility, above all for international visitors. For example, charter flights from the UK to Natal were cancelled in the wake of the recession. Direct flights to the region from Europe are now almost wholly dependent on the Portuguese carrier TAP and from the US are very limited. Although new airport infrastructure is being built in the region to accommodate additional passengers, there was a general sense that insufficient effort was being put in to lobbying airlines to initiate new routes. One delegate was even calling for a new Northeast airline to be established to address this issue. Inevitably the complexity of the market will continue to increase and the level of sophistication of investors will grow. Against this background the right strategic investment advice for investors and the ability of developers to correctly “package� their projects to attract new capital are becoming critical success factors. A good locally based understanding of the market and its most important trends is an essential tool to get the job done right and compete in the new market reality.
Mark McHugh writes for Invest in Brazil on Google Groups and is Chief Investment Officer of Brazil Investment Advisors, a consulting and investment advisory firm based in NE Brazil. He was until recently Vice President of Marketing Americas for Shell, based in the US. His extensive business know-how was developed during a thirty year international career in marketing, sales, strategy consulting, and general management. He is skilled in investment strategy, leading new business development initiatives, M&A, and managing new business start-ups. He has a keen interest in providing independent investment advice to those participating in the real estate market in NE Brazil.
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Real Estate
Lending Opportunities In Mexican Affordable Housing
T
he collapse of foreign investment in the Mexican affordable housing sector has created a significant opportunity for debt capital in search of compelling risk-adjusted returns on construction lending. Our confidence in this market is underpinned by continued strong fundamentals combined with increased government support of existing mortgage programs to provide exit strategies for newly developed housing units. We believe that current dislocations in the construction finance market, and commensurate yield decompression, are driven entirely by structural flaws in Mexico’s affordable housing sector and not by fundamentals.
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Real Estate
██ Strong Fundamentals As Mexico successfully winds down its first-ever counter cyclical monetary policy intervention we believe its sovereign debt looks more attractive at present than that of any other G-8 country. The countries central bank, Banxico, shows signals of rate tightening in 2011 buttress our view by easing inflationary concerns even as tourism and industrial, auto and consumable exports have rebounded sharply since reaching their respective 2009 troughs. With currency flows now moving in the opposite direction, and consensus expectations of 4.5% inflation by year-end, we see possibilities for peso strengthening as well as a case for peso-dollar swaps to revert to pre-crisis costs. Within this macro context, the Mexican mortgage industry trailed the broader 2008 economic slowdown by nine months or so and in our estimate, will lag the recovery by about the same length of time. Current consensus is that mortgage delinquencies, now approaching 8% industry wide, will not find bottom until Q4 of this year. Meanwhile, one million new housing units are required annually in order to keep pace with natural population growth. Despite the Mexican government’s unprecedented 90% direct and indirect participation in the funding of mortgages, the industry has struggled to keep pace with this demand. In the last 12 months the problem has exacerbated as home builders lost access to SOFOL (Sociedad Financiera de Objeto Limitado)-supplied construction finance; temporarily slowing the pace of development. Government sponsored mortgage programs simultaneously increased lending capacity, paradoxically leaving the industry in a state of high pent-up demand and readily available mortgage takeout finance which is stymied by the limited availability of construction loans.
██ Persistant Structural Problems On the other hand, the global credit crisis exposed multiple structural weaknesses in Mexico’s affordable housing industry, as well as some previously unforeseen tail risks. We view the abrupt flight of nearly all foreign investors in 2008 as a symptom rather than a cause of current construction lending market
dislocations. Rather, the SOFOL leveraged lending model itself has demonstrated itself to be economically untenable. First, mortgage banks were under-capitalized; even before considering the amplified systemic risks of being wholly dependent on the local mortgage secondary market as well as the risk of future unfavorable government rules on mortgage lending rates and practices. Second, regulators permitted mortgage banks to combine construction lending with mortgage lending, which in hindsight was an ill-conceived marriage of convenience as mortgage banks became dependent on construction lending as a means of securing mortgage origination fee revenue. Regulatory oversight failings at Metrofinanciera in 2008 and more recently at Su Casita, didn’t help matters either, and will further delay any return of domestic savings and pension flows into the secondary market; something that in our view is a necessary prerequisite to any eventual large-scale return of foreign capital. Which is all to say, the entire financial system that funded Mexico’s affordable housing industry has broken, and we think policymakers will not introduce viable alternatives until well into the next presidential term.
██ An attractive lending opportunity with a good shelf life That indeed is a bitter pill for the housing industry to swallow. However, we are very excited by the investment opportunities that this environment has created. For as long as dislocations persist in the construction lending market we will remain capable of lending to the industry’s most reliable developers at above market rates and with terms favoring the lender. Patrimonio’s recently announced $550m warehouse line from Bank of America Mexico suggests that we’re not the only ones eyeing this opportunity.
Lawrence McDaniel is chief investment officer of Axia Capital, a boutique investment and advisory firm headquartered in Mexico City, specializing in Mexican affordable housing, leasing, and alternative consumer credit. Lawrence@axiacredit.com
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48
Infras Invest World Brasil 2010 AD 7.5-9.8.indd 1
10/6/10 14:32:57
Latam
Real Estate
Real Estate Index
T
██ By James T. Anderson
he new global paradigm of lower returns, less leverage and reduced risk has made us very interested in looking at listed equities as a proxy for private equity real estate investing in Latin America.
This analysis focuses on how theoretical real estate indices would have performed over the past cycle in Latin America in an effort to determine if real estate equities track the broader market or if that relationship changes at different points within the cycle? A broader theme concerns the utility of investing through an index versus a real estate fund structure, which is the main vehicle used by the private equity real estate industry. The FTSE EPRA/NAREIT Emerging Americas Index, released in early 2008, was the first real estate index of its kind in Latin America. Unfortunately, the index does not cover the full cycle leading into the current recession but will certainly be useful going forward. Consequently, we used the Dow Jones REIT Index as a benchmark to compare regional returns during the 2003 to 2010 period (see following page). Our market cap weighted indices, denominated LatAm RE, RE Mexico and RE Brazil, were analyzed against the country ETFs and US benchmarks, and include all available data for listed real estate companies in Mexico and Brazil that derive a majority of their business from real estate investment and development activities.
Our primary observations are threefold: First, overall returns for our theoretical Latin America regional real estate index were much better, on an absolute basis, than the NCREIF and REIT indices for the period and suggest that they may be a competitive alternative for investors who seek real estate exposure in the region; Second, listed real estate equities were similarly uncorrelated as the NCREIF indices leading up the recession which suggests that they may behave more like fund investments than equities; and that as markets normalize we suspect the uncorrelated observations may resume; and Third, the weak correlations between the Mexico and Brazil ETFs to the Brazil and Mexico real estate indices, respectively, suggest that the country real estate indices may be useful for hedging purposes (i.e. the Brazil real estate index could act as a hedge against the Mexico country ETF and vice versa; or as a hedge for fund investments). In short, we argue that listed equities may be a better way to gain exposure to the Latin America real estate markets for many investors, but especially for investors who are sensitive to risk and have threshold needs for liquidity. Since there isn’t a NCREIF-equivalent index for Latin America efforts to quantify fund returns are subjective. Anecdotally, we
49
Real Estate estimate that fund returns in Brazil for the 2003-2010 period broadly fall in the 20% to 30% IRR range and that projected returns for funds in Mexico are much less promising, as most investments made after 2003 are under water with many projecting losses up to 50% or more. Given Mexico’s current lack of transactions, it may be a year or more before we know the true extent of losses. But overall, fund returns have been above average in Brazil and below average in Mexico. As a substitute, we use comparable US benchmarks, namely the NCREIF Opportunistic and Property indices. But even the NCREIF indices have their issues as well, namely a lag in data (due to the fact that NCREIF is appraisal-based vs. market-based) and a lack of data since NCREIF returns are quarterly which limits the ability to compare data sets.
Many believe that real estate fund returns generally track the overall markets, evidenced by the strong correlation between real estate and other asset classes during the current recession and, in fact, real estate may well under perform when all is said and done. In Latin America, we believe this to be especially true because the public and private real estate markets tend to be very integrated in terms of liquidity, cost of capital and breadth of opportunities.
Latin America real estate fund managers compete in the same markets as listed real estate companies, target the same invest-
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Real Estate ments and in many cases are simply capital partners with public developers. Increasingly, it is hard to distinguish between public companies and international funds in terms of what they do which begs the question: why pay the fees and lock up capital when an investor can just buy the equities, achieving comparable returns, and preserving liquidity in the process? Overall returns in Latin America outperformed major benchmarks in the US over the last cycle. Both the Brazil and Mexico country ETFs handily bested the major indices.
We found that by isolating real estate equities, the comparisons showed significantly lower volatility for the RE Brazil index (vs. the Brazil ETF), and lower returns for the RE Mexico index (vs. US comparables) and favorable returns for the RE Brazil & LatAm RE regional indices (vs. US comparables). We then broke the time period into pre and post recession in order to see how the different indices performed and there we found some meaningful contrasts. During the period 2003-2007, our real estate indices posted attractive uncorrelated returns but the interesting discovery was by combining the Brazil and Mexico real estate indices, the smoothing of returns produced a comparable sharpe ratio as the NCREIF indices as well as competitive uncorrelated returns, and lower volatility than the country ETFs.
The lower standard deviations of all three indices piqued our interest, since one of the possible applications is to reduce volatility associated with emerging markets. In the post-recession period, the real estate indices became highly correlated with the DJ REIT Index. We suspect that as new data comes in for the NCREIF indices that it will show increased loss severity given that NCREIF data typically lags REIT data by a year or so. The lag in NCREIF data makes correlation analysis difficult. But the overall return comparisons are quite notable. Another interesting observation is despite the higher volatility leading into the recession, differences in standard deviation between
51
Real Estate
the benchmarks and the real estate indices narrowed once the markets started selling off. In other words, everything became exceptionally volatile but the big jump was with the comparables, not the real estate indices. The next step of our analysis benchmarked the real estate indices against the country ETFs. We wanted to find out if it makes sense to isolate the real estate components versus simply owning the country ETF and, furthermore, if aggregating the Brazil and Mexico real estate equities into one basket would produce any significant impact on the risk-return profile for real estate equities versus the country ETFs? The findings are interesting for several reasons. First, we already knew that the RE Brazil index is significantly less volatile than the Brazil ETF but we didn’t know that it is weakly correlated to both the Brazil ETF and the Mexico ETF. Second, the RE Mexico index is strongly correlated to the Mexico ETF but weakly correlated to the Brazil ETF. Third, the RE Brazil index’ lower volatility and weak correlation to both country ETFs suggests that it may be uniquely applicable for hedging. To be sure, the total gains for the real estate indices are less than the country ETFs but they still handily beat the comparable US comparables. The next discovery that intrigued us was the impact of combining the Mexico and Brazil real estate indices into one market cap weighted index and looking at the pre and post-recession periods.
The result was an overall smoother return without sacrificing too much alpha or gains during the pre-recession period and helping to mitigate negative alpha, mainly associated with Mexico, during the post-recession period. In fact, the LatAm RE index gained 100% over the 2003 to 2010 period, nearly 1.8x the NCREIF Opportunistic index and 4x the NCREIF Property index. One clear benefit of indexing is hedging. For example, one could have shorted the RE Mexico index in 2008 and increased Brazil. Conversely, an investor could increase Mexico exposure and scale back on Brazil. A fund investor likewise could hedge an existing investment or increase exposure. There is no reason why an index could not be customized using a debt/equity hybrid or synthetic strategy in order to capture the kind of credit exposure an investor seeks in a particular market. We suspect that indexing in and of itself will not achieve the kind of exposure an investor desires, and that further research into a hybrid index that captures both equity and credit is the most likely application. In fact, we would argue that Brazil especially already prices real estate based on conditions in the credit markets, which is why we are seeing efforts to grow the lending side of real estate in Brazil. Yet, the main point the aggregated index illustrates is that an investor could have simply purchased a market cap weighted basket of listed equities in 2003 and realized very healthy risk-adjusted returns without sacrificing liquidity or the additional resources that a fund investment demands.
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Real Estate The liquidity issue is one of the most compelling reasons to explore indexing since the number one risk facing investors in funds is endogenous in nature, manifested by the tendency of managers to overcrowd a strategy. In relatively smaller markets, the consequences of this are amplified. Real estate markets in Mexico and Brazil have evolved to a point where foregoing the benefits of liquidity in exchange for alpha is no longer necessary. As with all research, the points discussed here are based on historical data and make no predictions whatsoever about future returns or performance. But then again, past fund returns don’t either.
James Anderson is Principal of Tierra Partners, an institutional real estate advisory firm, focused on the Americas region. He can be reached at james.anderson@tierrapartners.com
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Forex
The World Cup
Effect ██ By Kevin Sollitt
When the last issue of ALI was released market conditions warranted a pause for those involved in FX markets. A timely respite has been provided by the World Cup soccer tournament, evidenced in part by a drop in implied volatility from 19 percent to 14 percent over the first couple of weeks in June. According to wide-ranging conversations we’ve had with global partners, the stabilisation of trading conditions could not have come at a better time due to the exceptionally volatile and borderline irrational behaviour in FX markets during May 2010. Many have spoken of large-scale capitulation taking place, which added fuel to an already unruly fire of uncertainty & panic. The initial cause for concern was a severe meltdown in Eurozone sentiment that manifested itself through a precipitous drop in the EUR from $1.32 to a low of around $1.19; only just above its approximate launch level in 1999 and now a perceived ‘line in the sand’ for intervention. The speed and extent of the decline outweighed whatever fundamentally positive macro-views may prevail over the medium term and also overwhelmed the collective attention and focus of the world’s capital markets, igniting contagion fears last seen at the end of 2008. A complete meltdown was probably avoided by official ef-
forts between the Fed and ECB to keep swap lines open and credit flowing. Such sentiment again raises the possibility of a much-feared doubledip global recession, a dire situation that would starve established and emerging markets alike of much-needed access to capital so soon after the last great escape in 2008. This is important to avoid as it may cast doubts over the ability of our ‘global village’ economy to succeed, such as the funding of future collaborations like the 19 trade agreements signed by Venezuela’s Chavez and Portugal’s Socrates last month. (http://venezuelanalysis.com/news/5398) Regarding the USD, markets have somewhat counter-intuitively continued almost blindly buying the greenback despite the abundance of them from the printing presses, the US unemployment rate remaining very close to a recession-like 10% and signs of a Eurozone crisis being averted by implementation of fiscal measures and IMF support-France and Greece even raised retirement ages. Again, we think cause for pause exists if one is contemplating a new FX strategy-there are too many inconsistencies to make sense of it all right now and the boat is loaded with Dollar bulls and this view may be especially true when considering the arguably irrational pursuit of USD when other more attractive options are available in liquid currencies, especially those with higher interest rates that offer equal security, the chance of positive carry and also currency appreciation. Why look anywhere other than Brazil for all of these? We are still very bullish for the BRL over time. We offer that unless the view is for an imminent rise in US interest rates coupled with a large fall in unemployment, the time does not seem quite right to be fully invested in USD due to extremely overextended long positions against all other major currencies and continued stagnation at best of the US’ dire fiscal position; over 60% of the 50 US States are projecting 2011 budget shortfalls of 10% or more with a collective budget deficit of $55 billion, according to recent surveys.
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Forex At time of writing the G-20 summit meeting in Toronto is approaching and although markets are not yet functioning in a completely disorderly fashion, we sense potential for some official smoothing of currency rates should the situation worsen progressively and especially if any further moves are rapid. We also suspect that China may make noises ahead of or even during this conference to reduce international pressure and indicate its willingness to bring about greater flexibility in the Yuan exchange rate, which in and of itself should be another USD negative factor, providing further relief for the upward reversal already underway in EU and LatAm currencies. Due to the overbearing nervousness of the FX market evidenced by breakdowns in traditional correlations (e.g. Gold & USD higher simultaneously) we’d like to switch analysis this month from projections and instead offer some insights that may help readers cope with violent market swings and importantly, if taking market risk, allow preservation of capital to be maintained on a relative basis. In soccer terms, don’t let the other team score first! This month’s column is primarily intended to share ideas and opinions with those readers who may be new to Forex, perhaps via retail accounts or through separately managed accounts. All markets ebb and flow and it should be expected that in any strategy losses could sometimes occur. However being equipped to survive such rough spots both psychologically and monetarily could assist with ultimate goals such as future prosperity, and if readers are able to benefit from some reasonable tactics, these latent opportunities may become a little more within reach. We took an unaudited survey among FX contacts that considered the governing criteria that may have contributed to a variety of flaws within FX strategies in general. In conclusion we found that the weakest criteria were exhibited when traders: -Risked more than 5X equity in a volatile market (even the smallest stop-loss can get too big). -Added to a small losing trade too soon and/or several times in the misguided hope of recovery. -Entered a medium or long-term trade and became governed by short-term gyrations. -Entered a short-term trade and became governed by medium or long-term views. -Let profits run too far as conditions altered adversely without reducing exposure. -Did not follow a rule-based system such as using a stop-loss. -Used inconsistent risk/reward ratios, deviating from predefined risk/ reward profile (e.g. originally looking for 2:1 and settling for lower or inverse ratios).
We found that most of these errors might be avoided by stripping out the human element of decision-making and improved upon by following rule-based systems that define allocations by whichever method the trader or manager implements. For example, once a trade opportunity is identified, follow clear mechanics such as looking for a specific return on equity per trade, dependent on the market situation. Always use a stop-loss; even better use one that is correlated to the profit objective, e.g. an average 50% of the desired gain. -Choose one or two currency pairs that have the highest probability of reaching the target. -Exit the trade as soon as the target is reached, whether it is at a loss or a profit. -Place trades on a reactive basis thereby reducing event-driven swings where open positions are subject to knee-jerk reaction by the market at large, increasing risk of getting stopped-out. -If the reason for placing a trade becomes invalid, exit the trade. -Minimise event risk by closing or reducing positions over key data releases and weekends. -Live to play the next game! As with any other market, no component in part or whole of any such approach is guaranteed, yet experience gained over several different market cycles shared in this article could suggest that at the very minimum, an awareness of these principles may at worst serve as timely reminders that we all need a strategy and at best might help combat some of the nervousness and tough days that have and always will be a part of the floating exchange rate world, with pursuit of capital preservation and conservative growth the underlying goals. For our regular readers, the overall macro view for higher LatAm currencies are still intact, especially with attention turning to Brazil as hosts of the 2014 World Cup! Our forecasts are also published on Bloomberg. Good luck trading. Kevin Sollitt is Portfolio Manager, Paradigm Foreign Exchange (www.pfxonline.com), based in the United States.For further discussion or related information please feel free to contact the author directly: kevinsollitt@pfxonline.com, or join discussions with ‘Paradigm FX ‘on ‘Twitter’ or ‘Facebook’.
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Editorial
Investment Analysts Try Their Luck with World Cup ██ By Marc Rogers The run up to the World Cup is full of excitement, anxiety, and predictions. In this article, we highlight the analysis by financial companies of the seven Latin American teams that qualified for South Africa— Brazil, Argentina, Uruguay, Chile, Mexico, Paraguay and Honduras. Almost everyone has a theory about how teams and players will perform on football’s biggest stage. Some base it on experience, others a gut instinct or omen. Financial companies, however, prefer to use sophisticated quantitative models. UBS, Goldman Sachs, and JP Morgan assessed the prospects for all World Cup teams by applying traditional financial market models to the extensive statistical information available in football. They used factors such as historic performance, official world rankings, bookmakers’ odds and recent form to determine a team’s overall strength and, ultimately, to predict a winner. With a long football tradition and a strong track record in World Cups, there is every reason to think the next champion will be from Latin America. The region has hosted six and won nine of the 18 tournaments to date. Its players are renowned for their technical ability and natural flair, though today the best footballers invariably play in European leagues from a young age. But how will Latin American teams fare in 2010?
██ The Perennial Favorites: Brazil and Argentina By far the most successful Latin American football teams, Brazil and Argentina have reached the World Cup final 11 times and won seven titles between them. They are the only two Latin American nationalities to feature in Goldman Sachs’s client-voted “World Cup 2010 Dream Team,” with Lucio, Dani Alves and Kaka from Brazil and Lionel Messi representing Argentina. With the most titles (5), matches won (64), and goals scored (201), Brazil’s World Cup pedigree is unrivaled. Crucially, Latin America’s
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largest country is also the only team in the world to win a tournament played outside of its home continent, in Sweden 1958, USA 1994 and Japan/South Korea 2002. Since taking over after the 2006 World Cup, current manager Dunga has guided Brazil to victory in the 2007 Copa America and the 2009 Confederations Cup, which was also held in South Africa. It is no real surprise, therefore, that Brazil is once again Latin America’s best hope of bringing the Jules Rimet trophy back to the region. UBS concludes that it is four times more likely to win than its nearest Latin rival, Argentina (5%). Goldman Sachs also ranks Brazil first in its probability model, though its lead is cut by the inclusion of a ‘penalty ’based on how tough a team’s schedule is on average. The tournament draw is also a key factor in JP Morgan’s analysis, which concludes that Brazil is the strongest team but predicts an England triumph over Spain in the final in Johannesburg. Argentina last won the World Cup in 1986, in Mexico. The inspirational captain at the time, Diego Maradona, is now the team’s eccentric manager. On the field, Messi, considered the world’s best player at present, is the star of a team full of players in good form for some of Europe’s top clubs. This collection of high profile individuals and an impressive World Cup track record ensures Argentina is still a major contender for the trophy, despite a stuttering qualification campaign. However, statistical analysis suggests that the Albiceleste’s title bid will be under threat if it ties a knockout match: the country ranks bottom out of all 32 teams in JP Morgan’s penalty shoot-out metric.
██ Surprise Packages: Uruguay, Chile and Mexico The small concentration of teams to have won the World Cup makes it statistically unlikely that a new champion will emerge in South Africa. However, Uruguay is one of only five countries in the world to be a champion more than once. Mexico and Chile, mean-
Editorial while, are among the nations with an outside chance of upsetting the historical trend. UBS rates all these teams above 1.820, the lowest score for any World Cup winner since 1950, when the unexpected victor was…Uruguay.
reached the quarterfinals. Only Honduras failed to advance beyond the group stages, but still contributed to the success of the region by earning a hard-fought draw with Switzerland that sent Chile through to the knockout rounds.
The problem is that Uruguay has not advanced beyond the round of 16 since 1970, and only qualified for two of the previous five tournaments. After being drawn in a tough group with 1998 winners France and the hosts South Africa, Uruguay is not expected to go far in 2010. However, it remains by far the smallest country (by population) to win the World Cup, and the best proof that surprises can happen.
It was at the quarterfinal stage, however, that things went wrong for Latin America. Paraguay was edged out by Spain, the eventual winners; Argentina came unstuck against a ruthless Germany; and even Brazil, considered the strongest team by most measures, lost to the Netherlands. Only Uruguay survived, led by striker Diego Forlán, who was crowned player of the tournament by FIFA. ‘La Celeste’ eventually finished fourth, its best performance for 40 years, while an all-European final ended with Spain beating Holland 1-0.
Chile is the third highest FIFA-ranked Latin American team at the World Cup, and after a convincing qualification campaign—finishing second, one point behind Brazil—has the potential to match its best ever finish in the top four. However, the team’s preparations were disrupted heavily by the massive earthquake that hit the country in February. Moreover, Chile faces a tough fixture schedule, drawn in the same group as bookmakers’ favorite Spain and likely to meet Brazil early in the knockout stages. Central America’s strongest football team, Mexico, is another that has an outside shot at reaching the latter stages of this year’s tournament. In the last four World Cups, however, it has lost at the round of 16 stage, suggesting a problem against stronger opponents. All three financial companies expect Mexico to exit at a similar stage in South Africa, with hopes of advancing further resting on a few key players such as experienced captain Rafael Márquez.
██ Hoping For A Miracle: Paraguay and Honduras Despite beating Brazil and finishing above Argentina in the qualifying round, Paraguay isn’t expected to progress beyond the round of 16, the stage at which it has been eliminated three times before. Of the Latin American teams, Paraguay outperforms only Honduras in most metrics, largely due to its poor showings in previous tournaments. The notable exception is latest market odds, which are more influenced by the team’s convincing performances in the last year. Finally, Honduras appeared once in the World Cup before this year, exiting in the first round without a win in 1982. Ranked 40th in the world by FIFA and drawn in a group with Spain and Chile, it would be a big surprise if the Central American state is any more successful this time around. However, this isn’t likely to dampen the mood in the capital, Tegucigalpa: in the midst of a major political crisis last October, interim president Roberto Micheletti ordered a national holiday the day after the country secured qualification for the 2010 tournament.
██ The Results…
Uruguay’s success was one of the big surprises of the tournament: Goldman Sachs and JP Morgan predicted it would exit at the group stage, while UBS gave it a 14% chance of reaching the semis. None of the banks expected Paraguay to advance beyond the last 16, mainly because all wrongly predicted that Italy would win Group F. On the positive side, all ranked Holland and Spain as the leading contenders among teams that had never won the World Cup before. These two teams arrived in South Africa with a perfect record in qualification, and in the end form triumphed over history. Aside from the badly misplaced prediction that England would win the tournament, JP Morgan deserves credit for correctly forecasting that Holland would beat Brazil in the quarterfinals, and that Spain would reach the final. However, JPM’s quant model also predicted that Slovenia would beat Germany and Argentina on the way to the semifinals. UBS gave Spain only a 4% chance of winning the tournament but acknowledged that their model—which placed significant value on past World Cup performances—might underestimate the European Champions. Meanwhile, Spain was the only semifinalist that Goldman Sachs correctly predicted, though it did consider ‘La Roja’ second favorites (behind Brazil) to become champions. Goldman Sachs’s limited success in picking the World Cup semifinalists reflects its run of bad luck in making stock recommendations this year. A recent Bloomberg report highlighted that seven of the bank’s nine ‘recommended top trades for 2010’ made losses in the first five months of the year. JP Morgan has fared better than most banks during the crisis, and thanked its traders for a 57% jump in profits in Q1 2010. Meanwhile, UBS’ ‘top trade’ for 2010—to short the euro versus the Swedish krona—seems to be a good call as the Scandinavian currency is up over 8.6% against the euro in the year to date. That said, according to the 2010 Financial Times/Starmine awards, Goldman Sachs remains the top bank out of the three. GS received the prize for top US broker, while eight of its analysts received awards for stock picking (compared to four analysts apiece at JP Morgan and UBS).
At one stage during the World Cup, it looked as though all the glory was heading for Latin America. For the first time ever, four teams from the continent—Brazil, Argentina, Uruguay and Paraguay—
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