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Latin American Hot Spots Lure Investors

Some workers have their lunch in one of the subway tunnels of the new train line 12 that is under construction and could be open to the public use this year with 20 stations in Mexico city.
Susana Gonzalez | Bloomberg | Getty Images
Some workers have their lunch in one of the subway tunnels of the new train line 12 that is under construction and could be open to the public use this year with 20 stations in Mexico city.

After two years of slow economic growth and a wobbly equity market, Brazil's economy, the largest in Latin America, is forecast to expand in 2013 and investors are looking for stocks poised to benefit.

"Brazil is still a hot spot, it has been for the past six to eight years. But its economy was in stagnation" in the last few years, Alfredo Coutino, a director at Moody's Analytics, told CNBC. The economy grew just 1.6 and 2.7 percent in 2012 and 2011 respectively, slumping sharply from the 7.5 percent growth seen in 2010.

And with Brazilian growth faltering, the MSCI Latin America index climbed just 5.4 percent in dollar terms last year. Brazil dragged down returns, with the MSCI Brazil index dropping 3.5 percent. Smaller markets performed better. The MSCI Colombia index jumped 31.5 percent and the MSCI Mexico index gained 27 percent.

The economy in Brazil accelerated slightly at the end of last year and the recovery is expected to strengthen in 2013 with growth reaching 5 percent, propelled by increasing investments to complete the infrastructure for the 2014 World Cup, Moody's said.

(Read More: Emerging Markets—The Big Story of 2013?)

"There is a huge focus in Brazil on infrastructure investments, on improving the efficiency of the country from a logistics standpoint," said William Landers, head of Latin American equities at BlackRock. Besides the World Cup, plans for the 2016 Summer Olympics in Rio are also fueling development.

However, it's difficult to directly invest in Brazilian infrastructure because most engineering, cement, and construction companies are privately held, said Landers.

There is one infrastructure stock that is in the BlackRock Latin America Fund's top 10 holding—CCR. It is Brazil's largest toll-road operator that also manages a line in the Sao Paulo train system. The stock gained more than 40 percent since February of last year and Landers thinks there's more room for CCR to run.

Landers added that any stock related to urban transit in Brazil is attractive at the moment.

While the BlackRock Latin America Fund lost 3.2 percent last year, it still outperformed the MSCI Brazil index. Over a three-year period it gained 5.2 percent, according to Morningstar data.

But it's not just Brazil — Mexico, Peru, and Colombia also have ambitious plans for infrastructure development, said Moody's Coutino.

(Read More: The Safest Emerging Market Banks)

In Mexico, toll-road operators also promise growth, said Andrey Kutuzov, a senior analyst who works with several small-cap funds at fund manager Wasatch.

Mexico's toll-road landscape is similar to Brazil's 10 years ago, with fewer companies on the market and less capital chasing them, said Kutuzov.

This industry is still in its early phase with "high internal rates of return, a lot of growth opportunity and benign regulation," Kutuzov said. "Pinfra is by far the highest quality player in the industry."

Market sentiment in Mexico got a boost from the new President Enrique Pena Nieto's move forward in opening up the state-run energy sector for private investment, among other plans from his busy agenda for the next six years.

Further south, Kutuzov sees promise in Colombia's cement market which has three main players with strong pricing power.

"Colombia is an excellent cement market, it is an oligopoly with three players. Cemex Lat Am is the second largest," he said, adding that Colombia is a great growth market for cement.

Cemex Latam Holding, a subsidiary of Cemex Espana, ran a separate initial public offering last year on the Colombian exchange. The stock is at least 30 percent undervalued, Kutuzov said.

Another big player on the Colombian cement market, Cementos Argos, was recently added to the Harding Loevner Emerging Markets Advisor Fund. The fund gained 24 percent last year and 8.5 percent in the three-year period.

"Cementos Argos is a very competitive cement company in Colombia. They are getting rid of some of their secondary assets that really were not generating decent returns," said Rusty Johnson, a Harding Loevner Emerging Markets Advisor Fund portfolio manager. He said that the Colombian economy looks solid, with home building on the rise and the mortgage market poised for double-digit growth — which bodes well for cement demand.

But there are a few regional home building investments that Johnson has been avoiding. Last year the fund sold Cyrela Brazil Realty, one of Brazil's largest home builders, as well as Urbi, a Mexico-based construction company. The market is underpenetrated by home builders and the demand is there, but the returns in cash are disappointing, he said.

BlackRock Latin America Fund also reduced its exposure to Brazilian home builders in 2012, saying that despite the quick growth during the last three years, the companies have struggled to reach economies of scale.

Small-cap funds have more choices in the economies outside Brazil, but for the large-cap funds, low liquidity is an issue.

"Colombia is doing well, but there are few liquid names there. The same in Peru," BlackRock's Landers said.

Investors have to be willing to invest in companies with less than $1 million in daily trade in order to participate in these smaller markets, Landers said.

(Read More: Is the BRIC Era Over?)

BlackRock Latin America Investment Fund, with $562.1 million in assets, allocates 65 percent for Brazil and 24 percent for Mexico. The rest is divided between smaller economies, including 2 percent for Peru and 1 percent for Colombia.

Moody's called Latin America the world's second best performing region after Asia, but the problem for investors is that not all of the companies are accessible through the equity markets.

"We need to see more stocks listed to really be able to gain a bigger exposure to this growth," Landers said.

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Disclosures:

Disclosure information was not immediately available.

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