MichaelMolinski

SAN FRANCISCO (MarketWatch) — Latin America has had a good run over the first two months of 2012. The S&P Latin America index was up 14.5% year-to-date by the end of February. Could this signal a new boom?

First of all, two months is clearly not enough time on which to base a prediction. And second, Latin America is not the same place that it was in 1990. The region outpaced the world in the 1990s. The equity indexes of Peru and Colombia each gained more than 800% over the decade ending Dec. 31, 2009. Brazil’s Bovespa index rose more than 300% in that period. Latin America mutual funds averaged an annual 16% gain over the decade, putting them at the top of the Morningstar list of major categories.

The commodities boom accounted for most of the lift. But with that boom over, my bet is that Latin America is not going to be a leader. Instead, it will be a place where you will have to look harder to find gold. Whether that search is for specific stocks, sectors of the equities market, asset classes, investment vehicles, or innovative investments, the gold is hidden deeper than it was in 1990. Latin America has become a place where identifying the trends that will shape the economies and markets over the coming years is the key to investing.

The possibility that the U.S. could face a long-term, Japanese-style downturn is just one of many reasons why investors should look to expand their target area. Putting a portion of your portfolio overseas — anywhere from 10 to 50 percent — reduces your overall portfolio risk while boosting your potential for higher returns in the long run. And yet, U.S. investors fail to take heed. A whopping 90 percent of U.S. investment dollars remains in the U.S…

If you’re looking to expand the Latin American portion of your portfolio, here are eight tips to keep in mind when investing in the region:

1. Diversify

Diversification is why you’re going global in the first place. A portion of that international portfolio should include Latin America. What has changed over the past few years is that “emerging markets” doesn’t mean what it used to. Developed markets have become riskier, and some emerging markets have become less risky. That may mean investors will have to explore more to find the right investments that provide a mix of growth, low correlation to the investor’s home country index, the right amount of risk for the investor, better value and a lower level of contagion vulnerability to global or regional shifts in economies or markets.

2. Follow the Middle Class

Latin America is rapidly gaining a middle class. Fueled by the commodities boom of the last decade, the middle class in Latin America has grown to 51% of the major economies in 2011, from just 41% in 2001, according to a report by Banco Santander. That growth has pushed buying power, and has favored consumer stocks such as consumer discretionary and consumer staples, media, wireless communications, and real estate, and some technology companies. Some examples of companies in those sectors include Companhia Brasileira de Distribuicao Pao de Acucar CBD, -1.19% and Companhia de Bebidas das Americas ABV, +0.00%  in Brazil, in Colombia retail chain Almacenes Exito SA (EXITO) and America Movil in Mexico AMX, +0.66%

3.The Search for Energy

As the middle class in Latin America grows, and indeed as global economic and population growth continues, the search for energy sources persists. That isn’t going to stop anytime soon. Recently, that search has led to more interest outside of Middle East oil and into Latin America, particularly as a source for oil and alternative energy. Major energy companies that stand to benefit over the long term are Brazil’s PetroleoBrasileiro, or Petrobras PBR, -3.70% and Argentina’s YPF SA YPF, +2.56% as is OGX Petroleo e Gas Participacoes SA OGXPY, +0.00%  of Brazil, and EcoPetrol EC, +1.92% of Colombia. Also, investors may consider Argentina’s Socieded Comercial del Plata SA (COME), which is active in the energy, transportation and real estate industries.

4. Growth in banking

Five factors have contributed to the growth in banking in Latin America: The previously mentioned growth in the middle class, access to the previously “unbanked” population, growth in deposits (and credit), a broader and expanding loan portfolio, and greater efficiency by Latin American banks. Itau Unibanco Holdings ITUB, +0.28% and BancoBradesco BBD, -2.00% are just two examples. But keep an eye also on new innovations in mobile banking, access to banking through ATMs, and credit card issuers. Read an earlier column about banking in Latin America.

5. Think outside the equities box

Don’t limit yourself to equities when investing abroad. Alternative assets such as private equity, bonds, commodities, real estate, and others are an important part of a Latin American portfolio just as they are domestically. Latin American bonds, either sovereign issues or corporate, can diversify your fixed-income portfolio and can sometimes bring higher yields than the bonds of the U.S. or European countries, often without a significant amount of added risk. Also, while the commodities boom is over as far as I’m concerned, that doesn’t mean these companies are bad investments. If all you’re looking for is exposure to the region, mining and iron ore producer VALE SA VALE, -0.83%  will probably still do well. Also, “commodities” is a broad term, which includes not only the commodities themselves but also mining companies and fruit and vegetable growers as well as basic materials manufacturers. Timber is one area that I think will do well over the long term, fueled by higher growth in lumber in Latin America, technology advances that allow trees to be harvested sooner, and global demand for exports as housing regains momentum.

6.Exchange traded funds and mutual funds.

Exchange traded funds and mutual funds are still good ways to lower your costs and diversify across the region. I’m on the fence as to which is better. ETFs are more flexible from a trading standpoint and can be less costly, but if you’re investing for the long term and want to put your trust in a professional rather than yourself, mutual funds can in many cases offer better value. As a long-term investor, some of the mutual funds I like are BlackRock Latin America MDLTX, +0.46% T. Rowe Price Latin America PRLAX, +0.40% Fidelity Latin America FLATX, +0.05% and J.P. Morgan Latin America. For ETFs, this depends in part of what you’re investing in. The iShares S&P Latin America 40 ILF, +0.28%  is a large-cap fund, tilted heavily toward industrials, while the SPDR S&P Emerging Latin America GML, +0.44% has a broader portfolio of about 100 stocks as does the Market Vectors Latin America Small-Cap Index ETF LATM LATM’s 80-company portfolio is also slightly tilted toward the consumer sector, which is a plus for investors looking to get away from large-cap industrial and commodity driven companies.

7. Invest in small capitalization companies

Over the next decade, investing in Latin America is going to mean more than just investing in the region as a whole. It will mean picking the right stocks, the right asset classes, and the right investment vehicles. And increasingly, that is going to mean small capitalization stocks. Small caps have the advantage of being lightly traded, and that means large institutional investors tend to ignore them. That gives small investors who have the time to research them an advantage. Plus, there are significant reasons for investing in small caps in Latin America now as an asset class: their correlation to U.S. stocks is lower than large-caps; their access to capital has increased; and they are tied more closely to the growth of local economies than are larger cap companies, which could be a significant benefit over the next few years.

8. Don’t ignore risk

Risk can be measured and quantified, either by looking at volatility (standard deviation), correlation (r-squared), relative volatility (beta) or risk-return measures such as the Sharpe Ratio. Get to know these terms. Even if you don’t fully understand them, you can use them to compare potential investments. Understanding risk is especially important when investing outside your home country. Find out what risks your investments are subject to such as currency risk, political risk, or regulatory risk, and weigh them against the stock’s potential returns.

Remember, diversity, stock-picking and following the long-term trends that are shaping the economies and markets are important when sitting down to research Latin America — and will make the difference to your investment portfolio.

Note: To avoid conflicts of interest, I don’t invest directly in Latin American securities