The portfolio is constructed from our universe of around 160 companies in Latin America, excluding Argentina and Venezuela. We do not cover commodity-related companies in this universe, but focus on most other sectors in the economy, retail, finance, education and infrastructure. The investment process is rigorous with a bottom-up research driven stock selection.
The starting point is our research. We have a team with an extensive track record analysing companies in the region, which is headed up by Sonia Villalobos. All our research is generated internally. The research efforts start with a thorough due-diligence process which leads to the forecasting of the next four years financials for each company covered; we do not use DCF. These models are built in-house - though more simple than a sell-side model they include full balance sheets, and cash flow models, but the focus is below the line. These numbers are continually updated with quarterly results, guidance or discussions with management. Sonia and her team are continually in contact with companies and are constantly updating their models. These earnings are then adjusted by a series of risk factors - that weigh the probability of this earnings growth not occurring (i.e. management issues, regulatory concerns, lack of coverage by sell-side analysts, lack of IR etc). From these earnings projections we reach a target PE which in turn gives us a target price. The target price is translated into USD and this is transferred to the valuation matrix which groups companies in the same sector, independent of the country. This permits an objective comparison of companies within sectors from different countries. The potential upside (difference between where the stock is trading today and the target price in USD) is what determines consideration for the portfolio (obviously taking into consideration other more technical issues, such as liquidity, volatility, limits, fit etc).
Investment ideas are continually proposed, discussed and challenged. Any laggards in the portfolio are also discussed. At any point in time the portfolio will have between 20-30 positions in the long book. The exit strategy is determined by the potential upside of other stocks in the universe or by a stock approximating our target price. The process is very bottom-up. These investment ideas are discussed by Sonia and Alessandro. They discuss whether a position should go in the portfolio, the size and also what is the best vehicle - ADR, local, swap or in some cases buying calls.
Close attention is paid to the liquidity of the stock. Our focus is on mid-cap sized companies, with a market cap between USD1bn-10bn where the ADTV is around USD500.000 per day. There is a strict adherence to risk limits also, amongst which are the sector limit of 25%, the single name stock limit of 15%, the maximum net exposure of 70%.
Our biggest countries are not surprisingly Brazil and Mexico, but our exposure is always the consequence of the stock selection process and is never a top down allocation decision.
In terms of hedging, we can and do short single name stocks although this is not possible in every country. We closely monitor the cost of borrowing the stock, and the general liquidity to avoid getting caught in any short squeezes. The average size of a short position is substantially smaller than the long positions. It is difficult to create a true hedge to the long book in this way, and so the difference is created with an option strategy on indices. This strategy is comprised of selling a call out of the money, and buying a put spread on the other side. We only use exchange traded options that are rolled quarterly.