Chile: a safe-haven with too many pitfalls

Latin America seems to be a hot" area these days. Investment professionals are touting 1997 as a year for growth across the entire re-gion. Yet many interested investors are unfamiliar with the countries and complicated regulations which apply to investment activities. Chile is a prime example of this lack of market knowledge.

Chile stands out as the most stable, successful economy in Latin America. Inflation was down to 5.5% in 1996, real GDP grew about 7% last year, and total market capitalization of the stocks listed on the exchange (the "Bolsa") are equal to 103% of GDP. Chile also has an admirable national savings rate of 14% -- by far the highest in the region. Chile is often seen as a safe-haven within Latin America. A wide variety of financial instruments are available, including government and corporate bonds, stocks, mutual funds and real estate funds. Although the Bolsa fell 15% in 1996, it started 1997 with a bang and still has considerable upside potential. Although the growth expectations for Chile are not as high as those of other Latin American countries, it still seems to be a worthwhile investment.

Unfortunately, there are several factors that should cause investors to carefully consider the appropriateness of investing large sums of mon-ey in Chile, despite the positive outlook for the country and its capital markets. Although the market cap of the stocks listed on the Bolsa is a large percentage of GDP, it is not a very liquid market. Thirteen private pension funds - AFPs - account for approximately half of the total investment in the stock market. Because of their size and their tendency to act similarly, they are market movers. The AFPs invest 20-30% of their portfolios in equities at all times and their presence has made the Chilean market relatively expensive. Chilean stocks carry a premium compared to stocks in other Latin markets. Even after two years of downward corrections, the Chilean market still trades at an average P/E of 16.5x on 1997 estimated earnings compared to 14.5x in Mexico, 14.2x in Argentina and 9.6x in Brazil, all of which have significantly higher five year growth estimates. The role of AFPs has probably caused premium levels to be higher than justified solely by the stability and outlook of the Chilean economy. Quite possibly, liquidity and relative value could be outweighed by a desire for diversification or stability within an emerging markets portfolio.

However, the "encaje" regulatory requirement is too important to ignore. Encaje is a rule of the Chilean Central Bank requiring 30% of any foreign investment in financial instruments to be deposited with the bank for one year, without any interest. This significantly lowers the total short term return on any investment.

Chile would be an attractive financial market, if not for the lack of liquidity and the return depressing effect of encaje. Until this changes, the best way to get Chilean exposure in an international portfolio would be to invest in either ADRs or Eurobonds. The largest companies listed on the Bolsa have issued these types of instruments. Although this technique limits the range of available investments, fund managers who use a top down approach can still meet many of their investment objectives.

Tami Benanav is with AFP Santa Maria in Santiago."

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