Strategy Note /

Democracy disappoints in LatAm

  • Democracy is not serving investors in LatAm well: economic hardship, inequality and corruption are usually blamed

  • But such flaws are often at least as bad in other emerging markets, without creating the policy paralysis seen in LatAm

  • The democratic "release valve" is the main distinguishing feature of LatAm, ratcheting up political risk in its markets

Democracy disappoints in LatAm
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
16 May 2021
Published byTellimer Research

Democracy is a good thing for citizens. Most would agree with this statement, but disagree on the underlying conditions needed to support a good democracy. Much more controversial is whether democracy is a good thing for investors. LatAm arguably offers examples where it is not. LatAm equities have underperformed global Emerging Markets and Commodities since the start of 2020 by about 30%. Poor politics may mean this gap persists.

LatAm the 'sick man' of Emerging Markets; 30% under- performance since start of 2020 despite commodity boom

If democracy is the best guarantor of long-term social justice and social stability then, of course, investors should welcome it, whether driven by pure financial return or ESG-type ethics. But if democracy leads to policy paralysis, wild swings in policy, or tyranny of the majority (with the consequent disenfranchisement and radicalisation of the minority) then the picture becomes much murkier.

And for EM investors, as ESG moves closer to the centre of the investment process and, if the returns outlook from the outperformers of the past decade – China, Korea, and Taiwan – start to fade, then this debate becomes much more relevant.

LatAm's democratic release valve

In emerging markets (EM), Latin America is perhaps the best example of this murkier assessment of the impact of democracy on investment returns and risk. Many of the factors blamed for high political risk in LatAm – such as economic hardship, inequality, and corruption – are prevalent elsewhere in EM, at times to a significantly worse degree. Arguably, what distinguishes LatAm from other parts of EM is the democratic release valve (ie highly competitive elections) for the frustrations borne out of these social injustices.

Those competitive elections in LatAm are resulting in highly fragmented legislatures, swings from left to right-of-centre policy, and short-termism in government policy. Even some of the economic guard rails painstakingly established over decades are beginning to crack: consider the passage of Covid-era laws which allow for an early drawdown of about 20% of private pension assets in Chile, the regional beacon for orthodox economic policy.

In the charts below, we compare LatAm countries with other EM regions along three measures of social injustice – misery index, Gini coefficient, and corruption perceptions – and two measures of democracy – Reporters Without Borders (RSF)'s press freedom score and the EIU's democracy score. We also chart the generally low count of seats enjoyed by the largest political party in legislative bodies in LatAm and present a table of upcoming elections in LatAm.

Economic hardship in EM is not unique to LatAm

Income inequality in LatAm is worse than in EM

Corruption in LatAm, except for 'clean' Chile, is similar to EM

Press freedom in LatAm greater than in most of EM

Democracy much more entrenched in LatAm than in EM

Legislatures in LatAm ex-Mexico are highly fragmented, constraining policy in emergencies and structural reform

Elections timetable in LatAm

Related reading

Colombia underperforming oil peers and cheap but struggles to reform, May 2021

Peru unlikely to nationalise Copper, the key metal for renewables and EVs, April 2021

The Brazilian blowout in equities in 10 charts, April 2020

Chile constitutional can of worms opened but still attractive versus LatAm peers, October 2020

Argentina equities: Never again! Easier said than done, August 2020

LatAm focus – protest dominoes, November 2019

Human rights presents a dilemma for ESG investors and US foreign policy, February 2021