Bradesco Asset Management (BRAM), one of Brazil’s largest asset managers with over USD 135 billion in assets under management, highlights the appeal that Brazilian Fixed Income denominated in hard currency has for foreign investors.
In November 2010, the firm launched the Bradesco Global Funds Brazilian Global Bonds, a Luxembourg UCITS fund with daily liquidity that invests both in Brazilian sovereigns and corporates denominated in dollars.
Clayton Rodrigues, Senior Fixed Income Manager of the firm and manager of the fund, reveals to Funds Americas his strategy and the characteristics of this product, that has nearly USD 70 million in assets under management.
Question: Which are the advantages of investing in the Brazilian external debt markets? What does this offer to investors opposed to local currency denominated bonds?
Answer: Brazilian external debt overall provides an excellent investment opportunity for international investors seeking yield, income growth and robust fundamentals, within a tax exempt / cost effective and liquid vehicle.
Brazilian Corporates are paying around 6-7% and Sovereigns ca. 3%, at par with other Emerging (and some developed markets) with much less attractive fundamentals. We expect the economy to continue to grow at +3% supported by strong domestic consumption (60% of GDP), 6% unemployment, fiscal discipline, controlled inflation and net debt below 40% of GDP all which will to continue to attract foreign direct and portfolio investments and consolidate further Brazil’s position as a top 5 holder of international reserves. All this paves the way for future credit rating upgrades from the current BBB level and investment gains.
Specifically, the advantages of investing through external debt for international investors are:
1. No IOF tax: investments in external debt are exempt from a 6% IOF tax levied on local currency and FX investments
2. No BRL exposure or hedging costs: the fund invests in USD.
3. Higher liquidity: the investable universe is highly liquid, whilst the secondary market for local debt is in its embryonic stage
4. Diversification: a boarder investment universe.
Q: What's the benefit of combining Government and corporate bonds?
A: Having the flexibility to blend corporate with sovereign bonds, is a powerful tool to enhance performance, diversify risk and smooth the fund's volatility, whilst improving liquidity.
Typically, Corporate bonds tend to perform better than Sovereign bonds in bull markets and vice versa, except in countries where investors trust corporations more than the government, leading to higher sovereign than corporate spreads, as we have seen recently with European papers. We can safely say that's definitely not the case in Brazil.
Q: Are there any liquidity constraints in your securities selection process?
A: Yes, as the fund offers daily liquidity, we screen and rate each paper on various metrics, liquidity being key. We consider the daily turnover, historical bid/ask spreads and the outstanding to help determine the level of liquidity, and ensure avoiding penalties which can accrue on less liquid bonds due to wider bid and ask spread.
Q: How diversified is the industry exposure of the portfolio? Is it a good proxy of the Brazilian growth? Do these types of bonds tend to be less volatile than the local currency denominated ones?
A: The industry exposure of the portfolio is well diversified and is a good proxy for the Brazilian growth; with 30% in Basic Materials / Industrials, 40% in Consumer, Utilities, Energy & Communications and 30% in Financials. From a foreign investor’s perspective, external debt offers reduced volatility as there is no FX effect impacting net returns in USD. In terms of liquidity, it is important to note that the secondary market for domestic bonds is not as deep as the Eurobond market and typically investors hold the bonds to maturity. As a reference I would note that in the external debt market we saw $38 billion of issuance in 2011 and $15 billion in just the month of January of 2012.
Q: What type of performance could you foresee for the portfolio this year?
A: In 2011 the fund returned +7% and untill the end of February 2012 it returned +2.47%. Currently the portfolio is invested 70% in Corporates with a Yield to Maturity of 6.3% and 30% in Sovereigns with YTM of 3% approximately. We expect the fund to continue to post solid returns as the fundamentals bode well for the market and we believe bond prices will catch up with equity markets.
Q: What's the average duration of the portfolio? And what's the average credit rating in the corporates portfolio?
A: Currently the average duration is 7 years and the credit rating profile is weighted towards BBBs with a 55% allocation, followed by 15% BBB- and the remaining 30% not below BB.
Q: Why should investors consider your fund now both in fundamental and technical terms? Are the current conditions adequate to invest?
A: We believe the conditions are right for investors to enter the fund at this time, given the flood of cash from QE programmes, unappealing growth and yield prospects elsewhere, Brazil stands out as an attractive risk reward investment option.
From a fundamental perspective, the fund provides access to Brazil’s growth offering Emerging Market yields and income capture with BBB rating and solid fundamentals.
Specifically, in the next four years growth will be furthered by investments in infrastructure needed to stage the upcoming Olympic Games and Football World Cup, this will be reflected in share and bond prices; yet bonds offer both price appreciation potential and coupons. Government bonds should also offer the same appreciation potential as Brazilian risk perception improves and spreads continue to narrow.
From a technical perspective; if we look at the Bovespa’s appreciation to date, it is evident that bond prices have lagged. All the technical signs coming from major stock markets are bullish, the VIX, the put/call ratio etc, and are all supporting this upward trend, thus bond prices should catch up. The fund will be a good vehicle to capture this trend, especially now as we are allocating 70% of the portfolio into Corporate bonds.
Q: How many positions do you have in the portfolio and how many issuers?
A: On average we hold about 30 positions diversified amongst 15 names out of a total of over 50 available names. We run our sector allocation according to our top-down assessment on the Brazilian economy and use bottom-up analysis to select the best names on a relative basis, within these sectors.
Q: Tell us a little about your investment process. How do you select the securities? How do you build the portfolio and how do you manage risk?
A: We are a fundamental investment house, with a 53 strong investment team, all based in Sao Paulo which gives us an edge as we are a relevant player on the ground. In a few words, I would say that our investment process blends top-down and bottom-up analysis with active risk management.
Our 5 strong Macro Economics team provides us with macro analysis and forecast which we leverage to build our base scenario and sector allocation. The bottom-up analysis comes from our team of 9 Investment Analysts who rate the Securities on liquidity, governance, fundamentals and technicals and then score these using our proprietary models. The scores are plotted against the sovereign curve signalling the most attractive risk reward investment options. Then, the Fund Manager selects names and allocates weightings at discretion – observing the MSCI 10/40 issuer concentration guidelines.
The portfolio building process is of course iterative. We hold daily meetings to monitor the investment universe and our holdings, discuss news flow and investment ideas. We present our portfolios to the Investment Committee on a weekly basis and report our performance on a monthly basis, though the fund has daily liquidity.
On your last point, there are 3 layers of Risk Management worth mentioning; first our Risk Management team runs simulations analysis of the portfolio with “what if scenarios” on a daily basis, second the Investment Analysts run stress tests on the portfolio holdings and third the fund is subject to the SICAV 10/40 guidelines on issuer concentration limits.
Q: What's your view on the Brazilian macro picture and for the evolution of the Real for 2012?
A: Our view is that the Brazilian economy should continue to grow in a sustainable way, in the 3-3.5% range, supported by a robust domestic economy which is growing at +4.5% and low inflation due to a successful mix of fiscal and monetary policies, which in my opinion supports a better Brazilian risk perception, and sustainable capital inflows. If need be, the Brazilian Central Bank might intervene to provide liquidity and absorb the excess which is positive.
But of course, Brazil is not an island and the performance of the Real also depends on external factors and will be impacted by monetary policies in the USA and Europe, commercial flows and commodity prices as well as risk perception.