Fynsa
If you are a regular reader of our newsletter, you may have noticed that our strategy notes have recently focused on international markets. This is no coincidence, as our goal has been to promote the wide range of investment alternatives and opportunities available, in addition to the advisory services we offer our clients in those markets.
This does not mean that we have neglected our local offerings, but we understand that, given the lack of visibility and greater volatility of local assets, it is our responsibility to promote a more comprehensive, diversified, and globally focused approach to investment management.
That said, we believe that now may be a good time to reevaluate opportunities in local markets.
The first round of the presidential election brought us some "surprises." The fact that Kast and Boric made it to the second round was the consensus result of the first round and what virtually all the polls had predicted. However, Kast's lead of close to 2% was less agreed upon and is one of the reasons why the market took it positively, as it gives him additional momentum to start the second round race (something that will likely be reaffirmed in the first polls).
The main surprise in the presidential election was the fact that Parisi came in third, defeating both Sichel and Provoste, the candidates from the traditional political coalitions. While it is difficult to identify Parisi within the political spectrum, his voters now become key to determining the winner in the second round.
In principle, Parisi's main initiatives are more similar to Kast's than to Boric's, including, for example, immigration issues, his proposal to generate efficiencies in public spending in order to redirect resources to pensions, health, and education, his idea of lowering corporate taxes and differentiating them based on company size, and the fact that, despite greater regulation, he believes in the private pension system based on individual capitalization accounts. That said, the "transfer of votes" has never been linear in past elections, and it will therefore be very important to monitor where these voters are heading in the coming weeks.
However, in more aggregate terms, we believe that the main positive surprises came from the legislative elections, with the center-right gaining significant ground and reaching 50% of the Senate. One of the main questions prior to the elections was whether the center-right could retain a third of the seats in both chambers. The May 2021 elections for mayors, governors, and constituents had meant a big setback in terms of representation for the governing coalition . This time, though, the result was the opposite, with the center-right gaining ground, getting 50% of the seats in the Senate and 44.5% of the seats in the lower house. In the latter case, this does not include the 3.9% obtained by the People's Party.
Having a balanced Congress is very important, especially in this context, as any change to the rules governing the work of the constitutional convention requires a two-thirds majority in Congress (a constitutional amendment) to be approved. As a sign, greater representation of the center-right is also positive, leading to a balance of power within Congress, also with a view to the future government.
What happens next? Moderate policy to seek the middle ground. We believe the market will welcome this moderation, as it could reduce uncertainty about the future. Signs of this have been seen during the week, for example, in the adjustment of both candidates' economic teams, although so far there have been no very specific proposals that would allow us to draw further conclusions.
Let's move on to the strategy.
How should the market react? Initially, the reaction was quite positive, although it has faded over the days, partly due to a less favorable international environment. But beyond short-term volatility, we believe the market should interpret these results positively, and rightly so. The confirmation of a second round between Kast and Boric eliminates some of the tail risks that were embedded in the election (such as not having right-wing candidates in the second round, for example), while the results of the parliamentary election (the biggest positive surprise) are positive not only as a political sign, but also because they will likely moderate the actions of the other two forces that will coexist in the future: the executive branch and the Constitutional Convention.
This new scenario should trigger a re-rating of Chilean stocks. It is important to understand that Chilean stocks carry a significant "institutional political risk premium" that currently has us trading at highly discounted valuations, with a 12M fwd P/E of around 10x and a P/BV ratio of 1.2x. These figures compare with 10-year historical averages of 16.9x and 1.74x, respectively. While we do not believe the market will return to those multiples, a re-rating to the midpoint of historical averages (-1ds) would imply a return of more than 30% based on both multiples.
Otherwise, we have good corporate visibility (with reasonable doubts for 2022). The IPSA is on track to show growth of more than 20% in profits since the end of 2019 (vs. 15% for EM), while we have 30% less profitability.
For now, we prefer to remain conservative in our target multiple, because we believe that, in the absence of "long-term visibility," the market has focused on valuing the "day-to-day" based on how interest rates move. In this sense, a sovereign rate at current levels (today at 5.6% for 10 years) is already consistent with an IPSA closer to 5,000 points (which is in practice what the market priced in before the corrections in recent days), while a rate of around 5.0% (levels we consider to be fairer) should be consistent with an increase of almost 20% in the IPSA, in our bullish scenario (considering current levels of around 4,500 points).
Investment decline
Today, at FYNSA, we have two financial funds with which we can gain exposure to the scenario described above:
In local equities, the Fynsa Total Return Fund, and in local fixed income, the Fynsa Deuda Chile Fund.
While the ultimate direction of the market will ultimately be determined by the outcome of the second round, short-term market improvement is likely to be driven by improved sentiment.
In local fixed income, base rates would have room to adjust by at least an additional 50 bp, especially at the longer end of the curve, also considering the setback of the fourth withdrawal of pension funds, which means that the performance of local fixed income should extend the improvements already seen in previous weeks. In this regard, the Fynsa Chile Debt Fund currently offers an attractive risk/return ratio.
Humberto Mora
Strategy and Investments
