By Ben Miller
Asset managers in Brazil have had to work hard in the past two years. The central bank’s push to lower interest rates forced them to stay focused. But it also boosted the performance of the domestic fixed-income and multimercado (mixed asset) funds that played the adjustment properly.
Now, improving GDP growth forecasts are lifting sentiment among managers – but a rate hike in April has complicated strategies once more.
The steady decline in rates that began in 2011 was already rewarding Brazilian fixed-income fund managers a year ago. Those topping the LatinFinance 2013 Brazil asset manager scorecard ranking still say clever anticipation of rates was the key to excess returns.
Gone are the days when managers could stuff portfolios with government bonds paying 12% or more. And while Brazil’s corporate bond market is growing, it will still take time to match the international one. So active managers keep putting their chips down to bet on rate movements.
“Throughout the last year there was this massive change in terms of GDP forecast,” says João Scandiuzzi, chief strategist at BTG Pactual Asset Management. The firm’s multimercado fund tops this year’s scorecard, and its debt fund comes in second. “We always had this bias that the growth would be slower than the government and the market anticipated. Our main bet was that the relaxation of monetary policy would go further than had been signaled by the central bank.”
BTG expressed this view by buying 2013 and 2014 interbank deposit rate (DI) derivatives, Scandiuzzi says. It also picked up inflation-linked Brazilian treasury notes, NTN-Bs, at the belly of the curve – between 2015 and 2022.
Now there is a rapidly growing preference from clients for Fundo de Investimento Imobiliário (FII) real estate funds, he says. For the multimercado fund, international investments include high-yield bonds, and rates in the US, Mexico and Colombia.
Brazil’s central bank, led by governor Alexandre Tombini, last cut rates in October. Many analysts had expected a hold throughout 2013, but creeping inflation prompted a 25 basis point hike, to 7.5%, in April, with more tightening expected.
“There are still pension plans with return targets that are above the current real rates. So fixed-income is dragging the returns to below the targets,” says Marcelo Giufrida, CEO of BNP Paribas Asset Management Brasil.
Pension funds must move into riskier securities to keep up, but it is a long process to prepare investors to face this less stable environment. BNP’s fixed income fund ranks fourth in this year’s scorecard.
Bradesco Asset Management, which runs the best-performing fixed income fund, also made money by betting on falling rates.
“Our strategy is to bet on the rising of the curves more than the rise in the short-term rates,” Reinaldo Le Grazie, director of fixed income and multimercado funds, says.
The increase in Brazilian rates, and one further down the road in US rates present an “interesting challenge”, Le Grazie says. It will require more of the active management that he and other fund managers have had to switch to in the past two years.
As the fund managers plan for potential interest rate and foreign exchange moves, they must also contemplate the inflation outlook. Price rises may not get out of control, but they nevertheless complicate the picture.
“One of the main mistakes of last year was the government pressuring the FX rate up, and that helped sustain inflation in Brazil,” says Gerald Medley, partner at Paineiras Investimentos, whose multimercado fund ranks second in the scorecard. “The government would prefer not to raise rates, but inflation is and will be above 6.5% – the maximum of the band. We believe rates will be increased.”
More macro-prudential measures are likely, Medley adds. Like the successful fixed income funds, Paineiras’s multimercado made strong returns after playing the interest rate decline properly. Now, he says, it has taken a lot of risk off the table.
Brazil’s fixed income market is growing for more than just sovereign borrowers, something investors agree is a good thing. But, non-government debt is still a long way from dominating portfolios. Government securities and derivatives make up the bulk of investments, as buyers cash in on changing interest rates.
BNP’s Giufrida explains that bonds represent about a third of his fund’s alpha, with two-thirds still belonging to market risks. Perhaps 10% of his firm’s assets are bank or corporate bonds.
The market for debentures, or local bonds, is also deepening.
“Liquidity was almost nothing two years ago,” Giufrida says. “Now it is 150 million to 200 million reais per day. It has gone from being essentially a loan market to being more of a bond market.”
Government initiatives to encourage new issuance and secondary trading are slowly turning things around. Infrastructure debentures – bonds to fund capex that offer tax benefits to foreign and domestic retail investors – are an example of an asset class created by legislation that is growing steadily.
BNP Paribas and Bradesco are preparing funds of funds to buy these types of debentures – and pass the tax benefits on to the individual investors, Giufrida and Le Grazie say.
Other funds are structuring similar vehicles. Fewer than 10 infrastructure debentures have been placed since the legislation approving them was passed in 2011, but the managers reckon more will be on the way after investors have reviewed the first few.
Topping LatinFinance’s Brazilian equity investor scorecard are absolute return funds free to pick stocks. Despite international investors trashing the Brazilian market, based on poor performance of the Bovespa, local managers insist there is plenty of value to be found. Listed companies that disappointed the markets before making a turnaround are a particular favorite. Funds that have performed best have taken a bottom-up view.
“We are still very bullish on the consumer sector,” says Bruno Baptistella, portfolio manager at Brasil Capital. Like many other high-performing equity funds, the Brasil Capital FICFI em Ações at the top of this year’s scorecard is an absolute return fund. His team can pick companies, steer clear of the commodities stocks that weigh down the Bovespa, and hedge positions.
Brasil Capital has simply built up positions in companies it likes, Baptistella explains. He highlights consumer firms that were punished by the markets but since turned around their results. This includes education provider Kroton and consumer goods producer Hypermarcas. Other picks include International Meal Companies, Cosan and Brazil Pharma. Real estate developer Cyrela is another they are betting on improving.
The GDP growth forecast of 3% for 2013 – following a dismal 0.9% in 2012 – has him optimistic on the performance of these companies. Baptistella describes 2012, with its movements in interest rates and exchange rates, as a “transition year” for Brazil’s economy.
Forecasts this year are much clearer, and more positive, Baptistella says. “There are unlikely to be large changes in interest rates. We expect a pick-up in the economy. We expect much better numbers.”
Baptistella also expects inflation to slow in the coming quarters. The expected interest rate hiking – his shop expects 100 to 150 basis points this year – shouldn’t cause major problems.
Brazilian stocks are still flowing out of many international portfolios. This means lower valuations and greater opportunity, both in the new issue and secondary markets, he says.
“We see a low position in Brazilian equities from international investors, and also from large domestic institutional investors, which may be an opportunity to build positions in Brazilian equities,” Baptistella says.
BNPP’s Giufrida echoes the view on international investors’ attitude towards Brazil. “It was too optimistic in 2007, maybe it is too pessimistic now,” he says.
In the long term, if rates go up in the US, this would pressure inflation in Brazil, and be tough for the country, Paineiras’s Medley says.
Next year’s elections could also interfere with policy and postpone some of the actions that are boosting the economy. Yet the difficulties of forecasting often flow through into returns for the local funds. “This volatility brings opportunity,” says Medley. LF