CFA Society Chicago Book Club:

How Latin America Weathered the Global Financial Crisis by Jose De Gregorio

Following the CFA Society Chicago 2015 Annual Conference held on May 7th which focused on emerging opportunities in Latin America, the CFA Society Chicago book club met on May 19th to discuss “How Latin America Weathered the Global Financial Crisis” by Jose De Gregorio.  The author was the governor of the central bank of Chile during the global financial crisis.

When analyzing Latin America, economists tend to focus on LA-7 which represent 90% of the output of Latin America.  LA-7 represents the countries with greater than $100B in GDP including Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.  Brazil and Mexico represent 2/3rds of the output of Latin America.

Leading up to the global financial crisis and depending on country until the 80s and 90s, growth was rather weak due to high inequality, low openness to trade, weak institutions, high inflation, and unsustainable fiscal policies.  Though in the 80s and 90s, structural reforms began to take place and the benefits were seen about a decade later.  Chile for example was one of the first to benefit after the structural shift to an independent central bank and a flexible FX policy.

Latin America was surprisingly resilient during the global financial crisis given the many shocks there have been over the 70s, 80s, and 90s.  Part of the resilience came from sound macroeconomic management and strong financial systems.  Structural reforms that took place prior to the global financial crisis such as floating FX rates acted as shock absorbers.  Other structural reforms included a more open economy and inflation targeting to help lower volatility.  It has been found that the greater the credibility of the central bank, the lower the volatility of inflation.  The commodity super-cycle of the early 2000s drove an expansionary boom in Latin America given the large dependence on commodity exports.  What also helped Latin America was China’s double-digit growth leading to higher demand of copper from Chile, soybeans from Argentina, or oil from Venezuela.  The commodity boom provided a nice cushion of wealth for the times that lay ahead.  The large build-up of financial reserves resulting from the commodity super-cycle were initially expected to be used as insurance against rising FX rates but the reserves ended up providing a cushion during the global crisis.  Some countries diversified their economies away from being dependent on a main commodity export which further provided downside protection.  Chile for example was able to diversify away from copper and keep it from being a driver of the business cycle.  Latin American countries also were less levered than the advanced economies.  Mexico on the other hand was the worst performer during the financial crisis due to the proximity to the US and large trade agreements.  Unlike during the Asian Financial Crisis, the terms of trade improved for Latin America helping to lead to a more resilient economy over the 08-09 period.

In summary, key drivers that helped Latin America weather the global financial crisis were a terms of trade boom, inflation control, the commodity super-cycle, structural reforms, credible central banks and financial systems, less leverage, sound macroeconomic management, and diversifying their economies away from being dependent on a single export.  Major risks to Latin American countries include falling commodity prices, continued populism, hyperinflation, poor infrastructure, a weak educational system, high inequality, and not doing enough on the reform front.


Upcoming Schedule:

June 16, 2015: The Billion Dollar Mistake: Learning the Art of Investing through the missteps of Legendary Investors by Stephen Weiss

July 21, 2015: On Saudi Arabia: Its People, Past, Religion, Fault Lines – and Future by Karen Elliott House

*(NOTE: Those who attend the July Book Club meeting will receive a free copy of “Superpower: Three Choices for America’s Role in the World” by Ian Bremmer)

August 18, 2015: Superpower: Three Choices for America’s Role in the World” by Ian Bremmer

September 15, 2015: The New Cold War? Religious Nationalism Confronts the Secular State by Mark Juergensmeyer

October 20, 2015: TBD

Five Hobbit Lessons for Sustainable Investing

In Devin Brown’s Hobbit Lessons: A Map for Life’s Unexpected Journeys, we learn five key lessons drawn from J.R.R. Tolkien’s timeless story The Hobbit. These lessons are well worth remembering and, in fact, may even help add meaning and value to your investment portfolio. And when it comes to sustainable investing, the lessons are particularly fitting because sustainability, by definition, causes us to think even more deeply about the long-term—how we earn our wealth, what we do with it and the implications our investments have on the environment and society.

Hobbit Lesson #1 – When adventure comes knocking, let it in—even if it makes you late for dinner, even if part of you says not to, despite what the neighbors might say. Saying yes to adventure will be good for you, and profitable too—though not in the way you might think” (32).

Developing a sustainable investment program is like embarking on a new adventure. The global sustainable investment market is growing rapidly and there are numerous strategies to help you achieve your goals. Although it may take a little longer to identify and analyze these material non-financial factors (and even make you late for dinner)—I believe that incorporating sustainable environmental, social and governance (ESG) analysis can reduce portfolio risk and generate long-term returns.

Global Growth in SRI Assets

According to the Global Sustainable Investment Review 2014, the world market for sustainable investing (SRI) has grown from (USD) $13.3 trillion in 2012 to $21.4 trillion in assets by 2014 (3). That’s a 26.9% compound annual growth rate (CAGR) in just the past two years. And, sustainable investment assets in Asia have grown at a 15.1% CAGR—from $40 billion to $53 billion over the same timeframe (4).

In my view, this remarkable growth in assets illustrates both the value of a more robust investment decision-making process and the dawn of a new era in sustainable investing.

Sustainable Investment Strategies

Hobbit Lesson #2 – Have your friends’ backs – someone has yours” (58).

As with any great adventure, there are a number of paths to choose from. The paths (or strategies) can demonstrate both your commitment to protect others from harm (e.g. having your friends’ backs) and lead you to opportunities where others can protect you from risk. GSIA reports that seven key sustainable investment strategies have emerged across the globe:

  1. “Negative/exclusionary screening: the exclusion from a fund or portfolio of certain sectors, companies or practices based on specific ESG criteria;
  2. Positive/best-in-class screening: investment in sectors, companies or projects selected for positive ESG performance relative to industry peers;
  3. Norms-based screening: screening of investments against minimum standards of business practice based on international norms;
  4. Integration of ESG factors: the systematic and explicit inclusion by investment managers of environmental, social and governance factors into traditional financial analysis;
  5. Sustainability themed investing: investment in themes or assets specifically related to sustainability (for example clean energy, green technology or sustainable agriculture);
  6. Impact/community investing: targeted investments, typically made in private markets, aimed at solving social or environmental problems, and including community investing, where capital is specifically directed to traditionally underserved individuals or communities, as well as financing that is provided to businesses with a clear social or environmental purpose; and
  7. Corporate engagement and shareholder action: the use of shareholder power to influence corporate behavior, including through direct corporate engagement (i.e., communicating with senior management and/or boards of companies), filing or co-filing shareholder proposals, and proxy voting that is guided by comprehensive ESG guidelines” (6).

Across these investment strategies, GSIA reports that the largest strategy globally is negative screening/exclusions ($14.4 trillion), followed by ESG integration ($12.9 trillion) and corporate engagement/shareholder action ($7.0 trillion). Negative screening is the largest strategy in Europe and ESG integration dominates in the United States, Australia/New Zealand and Asia.

The Association for Sustainable & Responsible Investment in Asia (ASrIA) reports that the top three investment strategies in Asia (ex-Japan) are ESG integration ($23.4 million), negative/exclusionary screening ($16.5 million) and sustainably themed investing ($2.0 million) in their 2014 Asia Sustainable Investment Review(10).

Importantly, Asian investors cite fiduciary duty, financial opportunity and risk management as their primary motivations for sustainable investing (20). Which brings us to Brown’s third lesson:

Hobbit Lesson #3 – Be fond of waistcoats, pocket handkerchiefs and even Arkenstones (just don’t let them become too precious)” (82).

In short, it’s okay to seek financial opportunity and enjoy “fancy” or valuable things. However, Brown draws out Tolkien’s theme and warns us that, “…if we let our possessions become too important, if we let them become too precious, they will eventually come to possess us and bring about our downfall” (81).

Emerging Themes in Asia

Interestingly, the data show that sustainability-themed investment strategies have had the highest asset growth rates—both globally and in Asia. ASrIA reports that game-changing issues like climate change mitigation are driving many countries in Asia to implement more supportive regulatory landscapes for environmentally focused investments like clean tech and renewable energy (14). The four key themes emerging in Asia include new opportunities for clean energy, green bonds, conservation finance and impact investing.

Clean Energy

Bloomberg New Energy Finance expects that over US $250 billion per year will be invested in Asia’s clean energy infrastructure through 2030. Although renewable power is expected to produce a third of the region’s electrical power by 2030, even more coal and oil-fired electric generation can be expected to be used to meet the region’s growing energy needs—and that will lead to a significant rise in emissions as well (21).

China is already the world’s largest energy consumer and it’s expected to increase its energy use by 60% by 2030. Therefore, investment opportunities should abound across Asia as the region attempts to transition to a more sustainable, and environmentally friendly, low-carbon future. In the Philippines, the National Renewable Energy Program (2011-2013) plans to triple renewable capacity to 15.3 GW by 2030. In India, multiple policies have been deployed to increase renewable power such as Renewable Purchase Obligations, Renewable Energy Certificates (“RECs”) and favorable State Electricity Regulatory Commission (SERC) tariffs for mainly private-investment driven renewable generation—though coal will still be a major fuel over the next five years. In Thailand, renewable energy makes up 12.2% of capacity and the Alternative Energy Development Plan (ADEP) (2012 – 2021) has set an ambitious 25% target (22).

Green Bonds

KEXIM Bank in South Korea issued the first green bonds in Asia in 2013. Although the market is still in its infancy, first movers like the Asian Development Bank (ADB), the Development Bank of Japan and Taiwan’s Advanced Semiconductor Engineering have also issued green bonds. And the Chinese government has decided that green bonds will be an important part China’s financial market reform (23).

Hopefully, proceeds from green bonds will help the region finance large-scale energy and environmental projects that will support its transition to a low-carbon growth model. However, investors will need to be cautious and seek full disclosure, transparency and an independent evaluation of these new financing vehicles to ensure that investor expectations can be met (23).

Conservation Finance

The scale of Asia’s economic growth is creating incredible financial wealth but inevitably depletes natural resources and increases the risk of pollution. Globally, we’ve lost 50% of the world’s mammals, birds, amphibians and reptiles over the past 40 years due to human activities that destroy habitat or over-exploit fishing and hunting. Examples in Asia include degradation of natural forest in Indonesia and Cambodia and threats to coral reefs in Southeast Asia by overfishing (24). So, it’s imperative that we protect these truly irreplaceable and invaluable treasures.

 Hobbit Lesson #4 – Remember not all that is gold glitters (in fact, life’s real treasures are quite ordinary looking)” (100).

Conservation finance is a form of impact investing in which part of the investment remains in the ecosystem to enable its conservation (the ‘impact’) and part of it is returned to investors. While more government and regulatory intervention is expected, there remains a US $200 bn – $300 bn funding gap to satisfy global conservation needs. Therefore, asset managers and banks have the opportunity to develop new products and advisory services for private, philanthropic and institutional investors with an appetite for conservation finance (24).

Impact Investing

Impact investing takes an ownership stake in equities, bonds or other instruments to generate social, health and environmental benefits with the expectation of subsequently exiting the investment. ASrIA surveyed Asian investors and found that they recognize financial opportunity, contribution to community and fiduciary duty as primary motivations of impact investing (26). I’d also note that Michael E. Porter and Mark R. Kramer argue that creating societal value is a powerful way to create economic value while meeting the vast unmet needs in the world in their article, “Creating Shared Value,” in the January 2011 issue of Harvard Business Review.

J.P. Morgan estimates that the global impact investment market could absorb between US $400 billion and US $1 trillion over the next decade. And the Rockefeller Foundation forecasts that Southeast Asia will be the next hub for impact investing. However, currently a shortage of viable investment products and limited access to qualified professional advice is reportedly holding impact investing back in Asia (25).

Putting it in Perspective

Part of the adventure of sustainable investing is the opportunity to generate both financial and social returns while addressing the world’s most significant challenges. At times, it might seem hard to believe that your investments can make a global difference but remember this final Hobbit lesson:

 Hobbit Lesson #5 – Recognize you are only a little fellow in a wide world (but still an important part of a larger story)” (122).

ASrIA reports that Malaysia, Hong Kong, South Korea and Singapore are the largest Asian markets for sustainable investments. In addition, Indonesia, Singapore and Hong Kong were the fastest growing markets since 2011 (11). As global and Asian SRI markets continue to grow there will undoubtedly be new risks but there will also be exciting new opportunities for investors!