How did the South East Asian crisis hit Latin American investment? Rachel Oliver and John Lappin assess the impact and look at regional developments

While Latin America has experienced some of the pressures the Asian markets came under pre-crisis, it appears to be more resilient in terms of its fundamental economic position. It should not provide any shocks.

When the Asian crisis happened it increased the risk premium for all emerging markets. By that time the Eurobonds and Brady bonds were trading at very tight spreads. It was a wake-up call highlighting the risks of emerging markets in general," says Erda Gercek, global strategist for emerging markets with Citibank Global Asset Management in London.

During the crisis, those Latin America countries with significant imbalances in their economies were hit hardest, hence the difficulties faced by Brazil. "But in all these markets the policy makers showed incredible willingness to tackle these issues, both during the crisis and after it. In Brazil action was taken on both the fiscal and monetary side," says Gercek.

He also sees the Latin American economies as more resilient. "The economies are very balanced. It is not like Asia where they had an overgrown financial sector which was financing the corporate activity, on the back of massive savings counts."

However, the crisis has changed circumstances. "The region has been adjusting to a new reality of a slower growth environment, with upward pressure on prices so inflationary pressures due to currency weakness and further deterioration due to external balances on the current account," says Emily Alejos, a Latin America portfolio manager with BEA Associates, part of Credit Suisse Asset Management, in New York.

She notes that there is now a lower correlation with the US market, which has continued to perform well, while there has been some retrenchment in Latin America. "The ones that have done best are Argentina and Brazil and those are the ones that have very low export to GDP ratios."

US manager Panagora Asset Management runs a global benchmark strategy so it invests in all markets. Within this strategy, it has moved to an underweighted position, given the high valuations and returns last year of over 50% in dollar terms.

"The way we manage our emerging market strategy is a top-down strategy. The country allocation decision is a major decision. That is a major contributor to return," says Kristine Lino, senior investment manager at Panagora in Boston. Within this strategy individual countries rather than regions are compared.

She still sees important resonances from the Asian difficulties which add up to a bearish assessment of the region. To defend its currency Brazil was forced to raise interest rates from 20% to 40%. This will cut GDP growth to 2.5%, low by Brazilian standards. If it were forced to de-link the currency that would have severe ramifications for Argentina. Chile is continuing to run a tight monetary policy, restraining the market. Mexico remains dependent on continued US growth - growth which is slowing down, also carrying a political risk.

Lino adds that there are concerns for particular countries. With Venezuela, Chile and Mexico commodity prices have been falling for oil and copper. That is going to cause economic pressure and could impact GDP growth.

Attention has now switched to the impact of the devaluations on trade. Downward pressure on commodity prices is playing an important role leading to greater consideration on a country-by-country basis. But not all assessments are as bearish as Panagora's. Given the high correlation in the region, Citibank places more emphasis on bottom-up analysis taking "a stock-by-stock approach using sector analysis valuation techniques with less emphasis on top down factors".

Alejos says BEA is concentrating on trade issues. As a top-down manager, it looks at the macro-economic and political environment to make an assessment of whether to underweight or overweight a country.

Alejos believes Latin America may still be vulnerable to shocks from Asia but adds that it depends on the degree of the problem. "If it is something extreme like a devaluation in China or Hong Kong then I think the markets would be very vulnerable but if it is a continuation of what we have been seeing then I think they can hold up."

Gercek says that Latin America has other advantages, adding that when he moved to Latin American analysis from Asia, he found the transparency of the data was much more credible. "If you take Mexico, they are looking to the US with Eastern Europe looking to the EU. But unfortunately Asia does not have that benefit."

All three managers use the MSCI emerging markets free index for asset allocation and benchmarking. "What the free does is take into account any foreign limitations and any restrictions to foreign investment in a particular market," says Panagora.

MSCI itself believes it has an advantage, particularly from the point of view of European investors, because it already covers the developed markets.

"Our methodologies are similar for developed and developing. So if you expand your investment horizons to include developed markets, that is a fairly logical progression. We have seen this since the early 1990s. It is a natural progression," says Karl Lau of MSCI in New York.

MSCI does not carry figures but one of the alternative index providers, the International Finance Corporation, does have some approximatenumbers for emerging markets. "We reckon there was about $12.5 billion indexed t o emerging markets of which about three quarters were indexed to IFC investible indexes. Many more active funds and others with exposure are using them as their performance benchmarks or allocation benchmarks or sometimes both," says Peter Wahl of the IFC.

All three managers incorporate a decision on currency into the country allocation. Gercek stresses that Citi-bank closely monitors currencies but that the decision is made in the asset allocation or stock selection. Says Alejos: "We incorporate our views on the currencies on what we would expect on the dollar return for the market. It is part of the country asset allocation decision," adding that BEA sees pressure on currencies at the moment. JL"

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