With an investment management market still in its infancy, and locally managed funds underperforming their benchmarks, an indexed approach to Latin American markets can be a wise one. Barclays Global Investors (BGI), which runs approximately $1bn in Latin American indexed assets, sells indexing from the point of view of risk control.

BGI uses an individual country fund approach, though it encourages the co-mingled approach as well, for economies of scale and again for risk control. Few BGI clients remain loyal to a single market and tend to 'cross' funds within BGI's internal marketplace, and invest in a multitude of different weightings. Remaining indexed in one market can incur higher tracking errors due to the inability to obtain actual underlying securities. This means BGI, along with other index managers, will have to access the American depositary receipt (ADR) and global depositary receipt (GDR) markets and hold over-the-counter swaps or convertible bonds to maintain essential liquidity.

Out of all the Latin American markets, Chile and Venezuela are the ones where this type of diversification would be more commonplace, according to Peter Leahy, managing director of global structured products at State Street Global Advisors (SSGA) in Boston. Those two countries would be places where we have higher percentages of ADR exposure," he says. SSGA is equally weighted 50% in local stocks and 50% ADRs.

SSGA has $8bn invested in emerging markets indexed strategies, of which 40% is cap weighted in Latin America with an exposure to six of its markets. The portfolios track both the IFC and MSCI emerging markets indices in each country as opposed to following the local indices, as is true of most if not all index managers. "Increasingly around the world we are actually managing indexes to track the local indexes," explains Leahy. "But we haven't done that yet in Latin America. It is really a function of demand, and we haven't had that yet."

Most of SSGA's clients have a broad exposure switching country funds and utilising SSGA in the same manner as BGI - as a marketplace in its own right. Over the last 12 months, SSGA has crossed 40% of all its activity in the Latin American markets. While Leahy believes the main reason for buying an indexed product is cost, he stresses crossing as a benefit of using the indexed technique. "If someone wants to get out of Brazil and buy Mexico, and they are invested in one of our closed end country funds, they benefit from all our internal liquidity in terms of crossing opportunities and you don't get that typically with active managers." Notably, of its client base SSGA serves over 20 active managers which use its index funds to implement their own active strategies.

One of these is First Quadrant who utilise SSGA's and other indexed providers' products which are included in its tactical asset allocation programme which spans 40 countries in total. First Quadrant's approach to the emerging markets veers away from stock selection, opting instead to "generate alpha through country switching and accept the market return in each one" says Bill Goodsall, managing director.

"As far as getting the market return in the individual markets is concerned, unlike the developed markets where we use futures, we can't do that in the emerging markets as there aren't any viable futures so we have to do it through another route."

First Quadrant uses a quantitative modelling process, which comes up with a set of ratings, reviewed daily, that rank s each country from 1-100. Since the Asian crisis, the emerging markets have been attractive to investors, as is reflected in the Latin American markets tracked by First Quadrant - Chile (79), Mexico (80), Columbia (85), Argentina (87), Brazil (88), Venezuela (90).

Some say emerging markets can be a 'stock picker's paradise'. Goodsall disagrees. "The evidence doesn't support that terribly well and if you can get the market return through a suitable vehicle and you have a mechanism to switch between countries then you can do very well through that route."

Morgan Stanley's OPALS (optimised portfolios as listed securities), which to date have attracted $3bn of investment, are an example of Goodsall's point that you don't have to be a stock picker to generate good returns.

Listed in Luxembourg, OPALS track 48 MSCI and local market indices. The investor can buy them in units and assign them to the country funds of their choice. The units are used to buy an underlying related basket of equities to get the performance, dividends, corporate actions and tax claims. Morgan Stanley then implements a securities lending programme on the underlying portfolio which it splits with investors 50-50. From January-September 1997, the Argentina product returned 34.82% against an index of 34.92%, Brazil 52.66% against 54.99% and Mexico producing 55.33% just under the index return of 56.10%."

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