Fund managers are shifting the composition of their portfolios to protect themselves against further slowing in China. That is bad news for exporter Brazil, but good news for Mexico, which has low trade exposure to Asia and which is starting to claw back the export share and wage competitiveness it lost to China.

After China joined the World Trade Organization in 2001, Brazil boomed due to a seemingly endless Chinese appetite for soybeans and iron ore, while Mexico's manufacturers struggled to compete with cheap goods in their main U.S. market.

Brazil has grown almost twice as fast as Mexico in the last decade and overtook its northern rival as Latin America's biggest economy in 2005, becoming a darling of investors.

But a recent soft patch in Brazil and a slowdown in China's breakneck growth are prompting some investors to take another look at Mexico's strong ties to the United States and the chances its new president will undertake major reforms that could push up growth.

In the seven months through July, foreign investors plowed $3.4 billion into Mexico's stock market compared with $2.9 billion in Brazil. That is no mean feat since the commodity-heavy Bovespa index of the Sao Paulo stock exchange has a market capitalization about three times greater than Mexico's IPC .MXX, which is more skewed to local consumption.

This upsets the trend of recent years. Brazilian stocks attracted $7.1 billion in net portfolio inflows last year, compared with $6.2 billion in outflows from Mexico. Brazil scored a whopping $37.7 billion in inflows in 2010, while Mexico attracted only $640 million.

"The pendulum swung too far," Claudio Brocado, who helps oversee about $5.9 billion in emerging market equity assets at Batterymarch Financial Management, said of the buy Brazil rush. "The pendulum has swung back in Mexico's favor. That tends to happen time and again."

Many still expect Brazil to rebound given record low official interest rates, a raft of government initiatives to boost growth and an expected wave of infrastructure spending ahead of the 2014 soccer World Cup and the Olympics in 2016.

Data from funds tracker EPFR, which is seen as a leading indicator for portfolio investment, showed the biggest inflow into Brazilian equity funds in three months last week, following China's approval of $150 billion in infrastructure projects.

China's 7 percent-plus growth still far outstrips the United States and Mexico, but this has almost halved from before the financial crisis. While the direct economic impact on Brazil may be limited, the effect is felt in the stock market, where almost 40 percent of stocks are linked to commodities and energy.

"The flows now are driven by the perception that Brazil's wagon is firmly hitched to China, which is slowing and changing its orientation in a way that reduces commodity and energy intensity," said Frances Hudson, global strategist with Standard Life, which manages $260 billion in assets worldwide.

The share price of Brazilian miner Vale (VALE5.SA), the world's largest iron-ore exporter, has fallen in tandem with Chinese ore prices and BlackRock fund manager William Landers said he has moved from overweight to close to neutral on the company.

"In the equity market, it definitely has a bigger influence because of Vale," Landers said of China's slowdown. "China still sets the steel price, sets the pulp and paper price."

REGAINING AN EDGE

Brazil still accounts for two-thirds of the $4.7 billion Latin American Fund that Landers manages, but he has increased exposure to consumer-oriented stocks recently instead of those that might take a hit from China.

In Mexico, BlackRock likes drinks company Femsa (FMSAUBD.MX) (FMX.N), which owns the successful Oxxo convenience stories, and cell phone company America Movil (AMXL.MX) (AMX.N) - both indirect beneficiaries of the country's strong exports to the United States.

While still recovering from recession, the United States is expanding more strongly than most developed economies - especially in Europe - and the U.S. Federal Reserve's new round of stimulus underscores its commitment to growth.

"If export industries are doing well and those folks want to buy cell phones, that's where America Movil benefits," Landers said, adding he also likes broadcaster Televisa (TLVACPO.MX).

Mexico's export growth caught up with China's in 2010, when the country also began to win back some of the U.S. market. It now has a record 12.9 percent share of goods imported by the United States, just short of China.

Finance ministry officials point to a narrowing wage gap in manufacturing as Chinese labor becomes more costly. In 2007, hourly Mexican manufacturing wages were 238 percent higher than in China, but are now just 7 percent higher.

As well as proximity to the United States, Mexico also enjoys strong patent protection. Barclays Capital also says that specialization in high-value sectors such as autos and telecommunications equipment has helped manufacturers gain an edge over China.

Mexico has a particular advantage in bulky goods, which can take four to five weeks to ship from China. The country is the world's biggest exporter of flat screen TVs, the second biggest exporter of two-door refrigerators and freezers and the fourth biggest exporter of cars, according to government data, while the aerospace industry is also growing rapidly.

Canada's Bombardier Inc (BBDb.TO) can truck a nearly-finished Learjet 85 from its plant in the central state of Queretaro to Wichita, Kansas, for final assembly in two days, according to Mexican quality manager Norman Thompson.

SWEET SPOT TO LAST?

In contrast with Brazil's strong commodity weighting, Mexico's IPC stock index is two-thirds composed of consumer stocks such as telecommunications, retailing and beverages.

Batterymarch's Brocado said this helped explain the IPC's performance this year. The index is up nearly 9 percent in 2012 and is heading for record highs compared with a 7 percent gain for the Bovespa, which almost all came in the last two weeks after China boosted infrastructure spending.

"The index in Mexico is more defensive," said Brocado, referring to stocks that provide a constant dividend and stable earnings. "Index composition has acted in Mexico's favor in terms of relative performance."

Thomson Reuters' Lipper data show that funds with an investment focus on Brazil returned an average 6.74 percent in the eight months through August versus an average 8.17 percent return for funds focused on Mexico.

Still, the buying has made Mexican shares expensive compared with Brazilian stock. As of Friday, the MSCI Mexico index was trading at 16.5 times forecast earnings and the MSCI Brazil index was trading at 10.4 times.

Federated Investors fund manager Audrey Kaplan said this made Brazilian stock a good buy, given forecasts for average earnings growth of 18 percent to 20 percent over the next year.

"That gives you a good opportunity to get in when the market is lower," said Kaplan, who manages $500 million in equities.

Edwin Gutierrez, portfolio manager for Aberdeen Asset Management, said Brazil would attract a flood of investment if it dropped its IOF financial transactions tax, which is typical of the ad-hoc capital controls that annoy investors. Mexico has eschewed such controls.

"Foreign capital is welcome (in Mexico). There's a big checkered flag saying 'come in,' whereas in Brazil there is a stop sign," he added.

(Additional reporting by Herbert Lash and Gabriel Stargardter. Editing by Andre Grenon)

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