Don't be fooled by the Mexican stock market's slow start to the year. The country's push for economic reforms and the revival of the economy of its largest trading partner, the United States, are stirring investor interest in Latin America's No. 2 market.
International fund managers say recent announcements of reforms to Mexico's education system and telecommunications sector provide a positive backdrop for U.S. investors to keep putting roughly 30 percent of their allocations for Latin America into Mexican stocks and bonds.
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"You saw a lot of optimism around elections and the potential reforms," said Darren Capeloto, portfolio strategist focused on Latin America at Payden & Rygel in Los Angeles.
Mexican President Enrique Pena Nieto, in office since December, has managed to reach agreement with opposition lawmakers to push through reforms, the most important of which will be in the state-dominated energy sector this summer.
After broadly outperforming most emerging markets in 2012 with a 17.8 percent gain, Mexico's benchmark IPC index is down 2 percent so far this year. The telecom reforms have taken a toll on Carlos Slim's America Movil , which accounts for more than 15 percent of the Mexican stock market.
The mobile company's shares have fallen 22 percent in the year to date on investor fears that new regulations will force America Movil to sell assets, compounding earlier concerns about disappointing European investments.
"It is complicated news for American Movil itself in the short-term but clearly this is a positive development from the standpoint of potential growth," said Alberto Bernal, head of research at Miami-based BullTick Capital Markets.
A significant decline in Mexican bond yields and a stronger peso point to investor enthusiasm. Mexico's central bank reported in February that foreign investors poured a record $80 billion into the nation's stocks and bonds, almost five times more than in Brazil.
From the United States, Thomson Reuters' Lipper data shows the allocations of U.S.-based emerging market fund portfolios in Mexico has increased over the last four years, although not in a straight line. By the end of 2012, Mexico represented 5.22 percent of these portfolios of stocks and bonds, versus 4.26 percent at the end of 2009.
Mexico sends almost 80 percent of its exports to the United States and its factories operate in near lock-step with their counterparts north of the border.
"What we also find very interesting is to the degree and extent Mexico can participate in the growth now in the U.S. We will invest in the industrial groups in Mexico," said Joel Wells, a portfolio manager focused on real estate at Purchase, New York-based Alpine Woods Capital.
Infrastructure and housing are two areas attracting investor interest, according to Alpine. Wells pointed to Vesta SAB , an industrial real estate company, as a beneficiary of U.S. companies expanding in Mexico given it owns land around airports.
Investors in U.S.-based emerging market funds have pumped an estimated net $4.7 billion into Mexican stocks and bonds in the twelve months ending January 31, out of a total $15 billion of net inflows for the overall Latin American region.
Latin American assets held by these funds total approximately $117 billion, or more than a quarter of the $480 billion in assets under their management, Lipper data shows.
Mexican state oil giant Pemex funds about a third of the government's budget, is the world's No. 7 oil producer and a top exporter to the United States.
Pena wants reforms, including opening up the oil industry to more private investment, to lead to an increase in production.
"The bigger picture is that Mexico is in a structural transformation," said Capeloto, whose firm has $7 billion in fixed income emerging market assets, with Mexico his top pick in the region.
RATE CUTS AND CREDIT OUTLOOK
Other factors contributing to investor optimism in Mexico are the cut in benchmark interest rates to a record-low 4 percent and Standard and Poor's lifting the outlook for the country's credit rating to positive from stable.
S&P cited promising chances for the government to complete its reforms, which would likely lead to an upgrade of its low investment grade rating of BBB.
There has been so much good news surrounding Mexico that its central bank has warned that the inflow of fresh capital could create asset bubbles and strengthen the peso to the point that it stymies growth. The peso's advance is a test of the central bank's hands off approach to monetary policy.
Some economists say they are not concerned with the peso's strength unless it drops below 10 pesos per U.S. dollar.
BullTick's Bernal thinks the peso is undervalued by 20 percent. The peso currently trades at around 12.42 per U.S. dollar. He has a year-end target of 11.75.
"If the central bank starts to get too worried about the Mexican peso valuation at this time it would be reacting in an illogical manner. It is not expensive," he said.
(Reporting by Daniel Bases; Editing by Dan Burns, Tiffany Wu and Diane Craft)