Exclusive Look Into Latin American Real Estate: Q&A with the Managing Principal of Tierra Funds
May 24, 2016
Real estate is an asset class that can be used to diversify your portfolio. A great way to gain exposure to real estate investments is through ETFs. Tierra Funds recently launched a new ETF that tracks the Latin American real estate market. Although, investing in that region may be riskier than other developed nations, Jamie Anderson, the Managing Principal of Tierra Funds is bullish on the idea that the Latin American real estate market is attractive at this time. This is especially evident by the fund’s current YTDperformance of over 20%. Below are Mr. Anderson’s responses to important questions on this subject.
ETFdb.com (ETFdb): Tierra Funds, which is part of ETF Managers Group, recently launched its first ETF. What was the motivation behind the launch of the Tierra XP Latin America Real Estate ETF (LARE ) in December 2015?
Jamie Anderson (J.A.): The Tierra XP Latin America Real Estate ETF (LARE) is the first listed product of its kind to offer sector specific access to the growing real estate market in the region. My partners and I have been working in Latin America since the early 1990s and have been through multiple economic cycles. Last year, we looked at the relative value of real estate assets and concluded that prices in Latin America were approaching an extremely oversold level. Deciding to list in December 2015 was, frankly, something we did with a pretty high confidence level since, in our view, income producing real estate trading at 0.60x tangible book value presented a very compelling opportunity for the long term investor.
The LARE ETF offers the investor exposure to local equities from Mexico, Brazil, Argentina and Chile through a balanced, diversified methodology, focused on income and growth potential. Over 80% of the LARE ETF components are unavailable in any competing product which we think is a major advantage for the investor.
In addition to attractive income and growth potential, the LARE ETF offers low volatility and low correlation to major benchmarks, such as the broad MSCI Emerging Markets Index and the S&P 500. What distinguishes the LARE ETF is our multi-factor approach to component selection that ranks dividend yield, market capitalization and liquidity against the population set. In our view, real estate is unique in that it benefits from both global and local capital demand for income and perceived relative safety. Most importantly, favorable long term demographics in the region suggest that it’s still early to mid-cycle for many property types, especially housing – which matters because real estate investing on the back of an expanding market is a great way to potentially capture appreciation and dividend growth.
ETFdb: The Latin America Real Estate ETF (LARE ) has done really well YTD, up over 20%. Could you tell us the major reasons for this?
J.A.: Thank you, we’re really excited about the performance so far. LARE is actually up 22.3% year to date as of 5/5/16 and we’ve made two dividend distributions with a SEC 30 Day yield of just over 4% according to Morningstar data. The two major catalysts have been the Brazil rebound and the global shift back into emerging markets.
Even though Brazil makes up about 45% of the weights, LARE net asset value actually exhibits less than half the volatility versus the Brazil benchmark. I’d also point out that since inception of 12/3/15, LARE NAV is only 51% correlated to the S&P500 and 72% correlated to the broad MSCI Emerging Markets Index. So, there’s something unique about Latin America real estate that tends to zig when other assets are zagging, and, again, we think part of that has to do with both the kind of capital that invests in real estate but also the nature of real estate itself having bond-like characteristics. There’s a saying from my early days in Mexico that real estate is slow to go down in a recession but first to go up when investors sniff a recovery around the corner and that appears to be what’s happening in Latin America right now.
We are asked frequently if the rally can sustain itself? Our view is yes, but we feel it’s increasingly necessary to be tactically selective and to lower one’s risk profile. The LARE ETF is a great way to achieve these goals. A large part of the rally this year has been driven by currency appreciation. In fact, the Brazil stock market index (IBOV) is still trading at 11x trailing earnings, so there’s definitely appreciation potential there. The question is will it be market wide or more sector focused? While we are bullish on Brazil overall, we view a tactical shift into real estate as an ideal way to maintain exposure, get paid to wait for broader growth to return and reduce one’s risk profile all at the same time.
Lastly, since inception, LARE NAV generated 41% alpha as of 5/5/16 versus 36% for Brazil, -3% for Mexico and -6% for the MSCI Emerging Markets Index. What this means is when you risk adjust taking things like volatility and beta into consideration, LARE NAV has delivered better quality returns versus the major regional and global alternative products.
ETFdb: What has been the trend in the Latin American real estate market in the last few years?
J.A.: Broadly speaking, Mexico and Chile have seen steady appreciation of real estate values on the back of stable economic conditions marked by low inflation and growing consumer bases. Argentina only recently re-emerged onto the global scene and we are very optimistic about a resumption of growth there, but it will take some time. Brazil, as many are aware, is in its third year of recession but, we believe the country is on track to resume growth later this year or early 2017.
Mexico is really just chugging along well. Leading into the 2009 global correction, Mexico was clearly overbuilding in the housing and commercial retail segments but excess inventory was quickly absorbed by the REITs, fueled by local capital. We are very optimistic about Mexico and foresee more REIT IPOs as well as the first MLPs which are set to debut later this year.
Brazil’s real estate development cycle was very much interrupted by the recession, but certain property segments, namely industrial and low/middle income housing remain quite strong. Office development and commercial retail haven’t seen dramatic pullbacks in rents and there are signs that consumer spending is strengthening after a rather dreary 2015. That said, given the severity of the recession, real estate has remained surprisingly resilient. As we get closer to the second half of 2016, we expect the central bank to begin focusing on cutting interest rates. When that happens, real estate development is going to be a direct beneficiary.
ETFdb: Which regions of Latin America are expected to see real estate price increases over the next five years? And does LARE have exposure to those regions?
J.A.: Our experience over the last 20 years is that real estate on average appreciates 10% to 15% per year in USD. Granted, there have been rocky periods but over the long haul, real estate values appreciate nicely. Mexico and Brazil are in unique positions within the region as the secondary markets for real estate are now the major sources of financing. This wasn’t the case ten years ago. For the long term investor, this is an incredible opportunity to invest alongside local institutional capital and retain liquidity and the convenience of the public markets.
Combined, Mexico and Brazil represent about 95% of the LARE ETF’s weights. It is important to realize that for a USD investor, both Brazil and Mexico saw their currencies decline by about 40%. So, you’ve got a heck of a currency tailwind behind you in addition to assets being relatively cheap in nominal terms. That said, we’ve seen Mexico REITs getting consistent 3% to 5% rental increases across the board and the combination of local pension capital has only served to put a floor on cap rates. In fact, Mexico has become a very difficult environment for global private equity because local pension demand for real estate basically outbids global capital for assets. This was not the case 20 years ago when global private equity was the only source of financing.
Brazil is in a different situation where we are coming off of a base where nominal asset prices remain well below their long run historical values due to very high interest rates and recession. Brazil, for the USDinvestor, offers a compelling opportunity to invest in cheap assets in nominal terms but, again, with a very favorable currency tailwind. We think it’s a no brainer for somebody with a two to three year time horizon. One thing to keep in mind about Brazil is it’s a $1.5 trillion economy with a very robust consumer market. If the government follows through on fiscal reforms, which is looking like a reality, unleashing the consumer in Brazil will be a powerful engine of growth – and real estate will be at the center of that.
I’d like to mention Peru and Colombia which have seen a decent amount of private equity investment over the last few years. LARE does not have any components from either country yet but we are excited at the prospect of being able to add them when possible.
ETFdb: What exposure does the LARE ETF have to Brazil’s political and economic uncertainty?
J.A.: Brazil’s political climate has been a major focal point this year. As many already know, the Senate just formally approved that impeachment charges be brought against President Rousseff, which means that she will have to step down for up to 180 days, during which time there will be a formal trial. However, the fact that over 2/3 of the Senate approved of the impeachment measure, Rousseff is likely to resign from office since that majority would be sufficient to convict her. Vice President Temer is expected to assume the Presidency and many expect swift changes, including at the Finance Ministry and the Central Bank, intended to bring the country fiscal issues under better control. If these changes come to pass, as many believe, Brazil could be on a strong path to growth by early 2017.
Much of the uncertainty has already been priced in. Keep in mind that Brazil sold off pretty hard into February before it became clear that Rousseff’s government coalition was set to fall apart. Once that reality set in, investors came back with a fury. All of that said, we don’t expect smooth sailing. Brazil has a long way to go and volatility will likely remain elevated which is another reason why we feel strongly about LAREas a proxy for Brazil exposure. The Brazil benchmark has YTD realized volatility of almost 49%. The LAREETF’s realized volatility over the same period is 24%. We mention this because, an investor can have exposure to Brazil without the Brazil volatility which we think is a very compelling proposition. Lastly, the LARE ETF’s dividend yield is about 100 bps better than the leading Brazil ETF.
ETFdb: There seems to be a lot of risk associated with investing in Latin American countries such as Brazil, Mexico and Chile. As such, what type of investor should hold LARE?
J.A.: Great question! If you haven’t noticed we talk a lot about volatility. We are big believers in achieving exposure through diversification and low volatility. It doesn’t hurt to have low correlation too. Volatility is a really great metric to evaluate investment options. While not a predictor of returns, low volatility in combination with low correlation can be a very powerful portfolio diversifier. LARE NAV exhibits low volatility versus the Top Ten Latin America products available and it is regionally diversified, so if there are problems in one country, the investor isn’t putting all of their eggs in that basket. Conversely, as we’ve seen with Mexico underperforming this year, the investor can capture some of the upside in other places like Brazil without taking on the Brazil volatility.
We believe the LARE ETF provides an advantage to the income investor but also offers the growth potential of emerging markets. We see the LARE ETF as a formidable proxy for Latin America exposure overall but also as an addition to a broad emerging markets allocation. Specifically, the LARE ETF in combination with a broad emerging market product or a broad emerging market fixed income product, could form the basis for attractive alpha generation and provide a boost to the blended income potential.
The Bottom Line
The Latin American real estate market might be undervalued, as Jamie Anderson stated. This is due to oversold conditions and low PE ratios in countries such as Brazil, Argentina, Mexico, and Chile. The Tierra XP Latin America Real Estate ETF (LARE ) is for investors seeking to increase diversification in their portfolio by investing in Latin America with relatively lower volatility when compared to other Latin American investments.