Europe is falling apart; the Arab spring is threatening to engulf more of the Middle East and Africa in war; the United States still has no idea who its next president will be and, oh yeah, the world is supposed to end in December.
Had enough volatility? Here’s a thought: move to Latin America to get away from it all! Or, perhaps, just move some of your money there.
For the first time in years, Latin America doesn’t have any wars, coups, hyperinflation, or currency crises threatening to rock the region’s economy and securities markets. In fact, several investment experts are predicting just the opposite.
“Emerging markets today are the low-risk investment,” Allen Conway, head of emerging market equities at Schroders, told Morningstar in a recent interview. “Whether you’re looking at any of the macroeconomic indicators, whether you are looking at levels of government debt, emerging are low and declining … (and the) fiscal situation in emerging is much better, current account much better, levels of reserves.”
A report last month by Ashmore Investment Management of London says that, for the first time, developed markets such as the United States and Europe can no longer be considered “risk free.” The implications of this are huge, especially when investors are using beta as a measurement of risk for emerging market securities. If developed markets can no longer be considered “risk free,” or beta 1, how do we measure risk in emerging markets?
Traditionally, investors have used three ways of measuring risk in Latin America:
Beta, a measure of the relative volatility of a stock compared with the market as a whole. The beta for the market (usually represented by the S&P 500) is 1.0. If a stock is above 1.0, it’s considered to be riskier than the market. Beta is often used alongside “alpha,” which measures a security’s returns above the expected investment performance of the market.
R-squared, also referred to as correlation, measures how closely a security has mirrored the market (in Latin America, either the local market index or the S&P 500). The value of R-squared ranges between zero and 100. The closer it is to zero, the less the security’s returns “correlate” to the market index.
The third is standard deviation, a measure of volatility, which looks at how much an investment’s return has fluctuated from its own longer-term average. It’s important to note that higher volatility doesn’t necessarily mean the security has greater risk, because standard deviation quantifies the variance of returns, but doesn’t differentiate between gains and losses.
So how do you measure risk in Latin America? More importantly, how do you pick the right securities with the right amount of risk for you? First of all, it’s important to note that how much risk you take on depends on factors such as your age, risk tolerance, and total investable assets. Once you have an idea of what your investment goals are, you can begin to pick stocks in Latin America depending on their level of risk. However, for the majority of U.S. investors, your Latin American portion should never be more than 3 to 20 percent.
Below is a list of the top-ten holdings in the S&P Latin America Index. You can also invest in this index as an exchange-traded fund through the iShares Trust S&P Latin America 40. The list shows the beta, and the volatility (standard deviation) over nine months. Note: I used the American Depository Receipt, FMX, to represent Fomentos Economico Mexicano instead of the locally issued shares because of data availability. You can also research these stocks on your own. I used MSN Money to find beta, and Marketocracy for volatility.
I didn’t include correlation in this list, mainly because each investor has his or her own individual preference for what benchmarks to compare the securities to, and different time horizons.
In looking at risk, time horizons are extremely important. For example, country risk plays an important part in your time horizons if you’re investing in Venezuela, where you’re probably going to have a short time horizon, while in Mexico you might have a longer time horizon. The data you gather on risk should reflect that time horizon.
Also, remember that Latin America could erupt again at any time. Risk — whether it’s political risk, currency risk, market risk, economic risk, or regulatory risk — can move at a moment’s notice. So, while Latin America does seem relatively sound compared to its history and to the rest of the world, keeping risk in mind will help your investment portfolio.
Finally, keep in mind that the list of stocks below are meant as an example to illustrate how risk should play a part in your investment decisions. While the list is mostly comprised of Latin American blue chips, your risk tolerance may be such that you are more comfortable in higher-risk small capitalization stocks.
read more: OIympus Wealth Management
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