Description

Thesis

Buy a successful out of favor closed-end fund trading at the largest discount to its NAV since the GFC that specializes in a country that is trading at the largest valuation discount to the US markets in 15 years and has numerous catalysts that could lead to near term outperformance.

The Mexico Fund – MXF

The Mexico Fund is a close-ended mutual fund with a pretty good long-term track record of competing well against the MSCI Mexico Index. Management is stable. AUM is $258 million.

The Mexico Fund is currently trading at over a 14% discount to NAV. The current discount is close to the largest discount to NAV since 2008.

 City of London Investment Group owns nearly one third of the shares. They are incentivized to put pressure on MXF fund advisors to lower the NAV discount.

Mexico Fund is positioned well for an economic recovery:

Mexican equities are trading at historical lows on a relative basis compared to the US yet have numerous catalysts that could drive significantly higher returns for longer term investors.

Valuation

According to FactSet as of end of May:

Using the past 15 years:

The relative valuation of Mexico compared with the US is in the 1% rank meaning the market has been more expensive 99% of the time in the past 15 years. 

 Mexico compares favorably to nearly every other country in the world.

Per State Street Global Advisors

Mexican stocks have gone nowhere since 2013 and actually declined during the Trump administration’s term as they pushed their anti-immigrant agenda. Throw in the usual cartels and corruption argument and add a global pandemic and US lockdown and the returns appear to make sense. Finally, pile on with the election of a populist socialist president and it is easy to see why investors didn’t appreciate Mexico.

USMCA

The US-Mexico-Canada Agreement updated NAFTA and took effect on July 1, 2020 in the midst of the pandemic lockdown. All 3 countries have 3 years to fully adhere to the trade policies at which point all stipulations must be fully enforced. There is an automatic sunset clause which can be extended.

It is hard to know the long-term effects of this agreement, but I believe the agreement stabilizes trade and removes the uncertainty of NAFTA ending. More importantly it positions Mexico to benefit from US – China trade problems. This issue is not disappearing with the Biden Administration at the helm.

https://www.npr.org/2021/06/13/1005969393/biden-spends-the-weekend-trying-to-persuade-g-7-leaders-to-push-back-on-china

Another example of how policy doesn’t always work in expected ways is Toyota’s response to the low income wage requirements.

https://asia.nikkei.com/Business/Automobiles/Japan-auto-companies-triple-Mexican-pay-rather-than-move-to-US

Mexican capital markets continue to make some progress.

https://www.businesswire.com/news/home/20210604005368/en/SoftBank-Latin-America-Fund-Invests-in-GBM-to-Accelerate-the-Democratization-of-Investments-in-Mexico

Mexico is the largest US trading partner (2020)

Mexico has a younger (median age 29) population and cost-effective labor pool that can help us address the supply chain issues we are clearly having. They are the most likely beneficiary of near sourcing trends.

Ray Dalio loves Mexico

Dalio’s argument is as follows:

1.       Prior currency declines

2.       And equity declines

3.       And rising rate differentials

Lead to capital account surpluses and a strong currency.

https://seekingalpha.com/article/4406641-bridgewaters-2021-global-outlook

The US 10 year Treasury yield is currently under 1.50% for a 5.25% yield advantage for Mexican debt. This difference has grown quickly in the last few months.

Mexico also has a strong fiscal position. The Mexican Debt to GDP has been in the 50%s but hit 60% in the pandemic and is forecast to remain at this level.  Contrast this with the US just hitting 130%!

The Mexican budget is in solid shape with a significantly smaller deficit than most developed countries. By comparison, the US deficit was in the teens in 2020 and could hit 10% in 2021!

Mexico has fiscal and monetary flexibility.

Mexican budget

Mexico benefits from US reopening through trade and tourism.

Tourism is critical to the Mexican economy and the number of tourists arriving in Mexico is on the rise. Pent up demand may help this number surpass previous years especially while some European countries and Canada continue to have travel restrictions.

The rejection of AMLOs MORENA party at the polls reduces political risk:

https://www.reuters.com/world/americas/mexicans-primed-vote-midterm-elections-seen-referendum-president-2021-06-06/

Risks

·       Political…it’s Mexico

·       US / China trade agreement or stabilization

·       US / Global recession

Catalyst

Mexican economy normalizes

Tourism returns

MCA starts to pay dividends

US / China trade war or problems

Unexpected narrowing of discount to NAV