The Ibovespa index fell a startling 28.37% in the 12 months to the end of March. Brazil’s sovereign bonds teetered on the cusp of downgrade during the same period. The Central Bank aggressively raised interest rates over the year — by two full points to 12.75% — in a bid to halt ballooning inflation.
The backdrop has made life tough for Brazil’s equity, debt and multimercado investors. Yet, as LatinFinance’s 2015 Brazil Investor Scorecard highlights, strong returns are available for the best managers. The Scorecard measures performance over one and three years to April 15, 2015, based on data from Economatica.
| How the funds are ranked LatinFinance’s 2015 Investor Scorecards are based on fund return data from Lipper and Economatica. | ||
The funds that perform best have managed risks carefully and employed a significant degree of creativity. They have emphasized quality stocks rather than cheap ones. They have taken a closer look at foreign companies in a quest for performance that is increasingly difficult for Brazilian stocks to deliver. And some have even used inflation to their advantage, particularly among short term bond funds.
That was the case, for example, for Santander Brazil’s IMA-B 5 fund, which returned 12.9% over the past year and ranks second on the scorecard for Brazilian debt performance.
The fund tracks the IMA-B 5 index, which is calculated by Brazilian capital market association Anbima. It is made up of sovereign bonds with a duration of up to five years, linked to the IPCA inflation rate. The IPCA stood at 8.13% in the 12 months to the end of March.
The fund’s strong performance is thanks to the joint effect of the factors that drive the benchmark, says Eduardo Castro, executive superintendent of investment funds at Santander Asset Management in São Paulo.
“The combination of a portfolio of inflation-linked papers with a relatively shorter duration has enabled funds that use the IMA-B 5 as benchmark to perform well,” he says. The state of the Brazilian economy, where slow GDP growth has combined with inflationary pressures to spook investors, has highlighted the defensive character of the product, which aims to provide protection against inflation.
Its performance has been boosted by active management of the portfolio within the limits allowed by the tracking strategy, Castro says. The fund purchases most of its assets in the secondary market, which is very liquid, and active trading enables managers to look for opportunities to nab paper that can provide a little push to the overall performance.
The question now is whether the fund will continue to perform once the economic winds turn again. Brazil’s economy is expected to contract this year as new Finance Minister Joaquim Levy deploys a number of hard medicine policies to try to set the country on a path to long-term growth. The Central Bank has shown no hesitation in hiking interest rates to stem inflation — most recently lifting rates to 13.25% at the end of April. If all goes to plan, inflation should eventually come down: but the unpopular nature of the measures could make it tough for authorities to stay their course.
Nonetheless, Castro sees good times ahead for the fund. “Looking forward, we still like the perspectives for this product very much,” he says. “But it may not be able to differentiate itself from the market as much as in the recent past.”
The fund expects inflation above 8% this year, and a still-high 6.5% in 2016. Gradually, however, it is the interest rate component of the fund, rather than the inflation one, that should take the lead in delivering performance.
The top performer among bond funds was BB Gestão de Ativos’ Previdenciário IDKA 2. Another index-tracker, the fund has also benefited from the effect of inflation, returning 34% over the past three years, and 12.7% in the past 12 months.
The fund tracks Anbima’s IDKA 2 index, which is also linked to the IPCA, but has a constant duration of two years. To keep up with the benchmark, the fund buys Brazilian Treasury bills with maturities of a few months to three years, trying to find the right combination of paper in the market to get close to the horizon of the IDKA — even though the short duration of the paper means they change on a daily basis.
The challenge of tracking the benchmark is compounded by the fact that the fund has withdrawals on a daily basis, while management fees and other administrative expenses put pressure on a product that focus on a narrow universe of assets, says Emilio Carvalhais, head of the short term fixed income division at BB Gestão de Ativos.
“Usually we employ a passive management strategy, but in some circumstances we can use some active elements as well,” Carvalhais says. “For example, we may want to add some duration or shorten it, to take advantage of the interest rate curve and achieve extra alpha.”
The short duration of the benchmark provides an advantage over long-term funds when it comes to marking to market any changes in the interest rate curve — not a particularly rare occurrence in Brazil. All things considered, Carvalhais says the fund has done well by keeping very close to the benchmark in the past year or so.
Beating the Ibovespa
Accelerating inflation and high interest rates may have helped some families of fixed income funds, but it made life more difficult for equities managers. Those factors were exacerbated by the fact that capital flows which once boosted the Bovespa have been moving in the opposite direction, in anticipation of the US Federal Reserve’s much-awaited reversal of monetary policy.
The recent performance of the Ibovespa index illustrates the challenges faced by the managers of equity funds in Brazil. After reaching a peak of almost 73,000 points in 2010, the index dropped to as low as 44,000 in 2014, and hovered close to 56,000 points at the end of April.
Sectors of the economy that delivered stellar performances a few years ago, such as retail or oil and gas, are doing much worse these days, affected by sagging consumption, low oil prices and a corruption investigation on an unprecedented scale at Petrobras.
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Fund managers say the secret to delivering results that can not only overcome such hurdles but also rival the performance of other asset classes is a strong focus on quality stocks with attractive valuations — rather than purely cheap ones.
One example is the BTG Pactual Absoluto FIC FIA fund. Its point of difference is that it restricts its number of large holdings to a few stocks that match a number of stringent criteria set by its managers. As a result, as few as ten companies comprise around 70%-80% of the fund’s portfolio.
“Our priority is to invest in premium companies that are leaders in their sectors — and not on those that may look cheap, but whose management does not have the same quality,” says José Zitelmann, head of equities in BTG Pactual’s asset management division. “We only invest in companies whose history we know, and whose dynamics we can understand. We want to have access to management, and to be able to talk to them.”
A similar philosophy is followed by the FC FIA BDR fund managed by IP Participações. The fund returned 21.1% over the past year and 48.5% over the past three, although despite the strong performance the fund closely missed reaching the top five of the scorecard.
“From the beginning the fund has sought solid and rentable companies that are managed by very competent people and whose interests are aligned with ours,” says Pedro Cezar de Andrade, a partner at IP Capital Partners. “We also want the stocks to have attractive valuations. It sounds simple and even obvious, but in practice it is hard to find this kind of stock.”
In fact, IP Capital Partners has had to look outside of Brazil to find the right stocks to meet the demands of the fund. Around 40% of the portfolio is made up of international companies, either in stocks listed abroad or those registered locally through Brazilian Depositary Receipts, BDRs, issued in the São Paulo stock exchange. In 2014, four out of the five biggest contributors to the performance of the fund — Berkshire Hathaway, Wells Fargo, Oracle and Liberty Global — were based outside Brazil.
The only native stock in the group was Itaú, which in fact was the best performer of all. In Andrade’s view, some sectors remain expensive in Brazil despite the sluggish economy: a result of investors flocking to good quality stocks as they become spooked on others.
BTG Pactual has a smaller exposure to non-Brazilian stocks, at around 10%. But it also focuses on a thorough analysis of individual stocks, rather than tracking indexes or betting on particular sectors of the economy. As a result, according to Zitelmann, the fund has managed to identify investment opportunities even in segments where the general performance of companies has been lackluster at best.
The fund looks for companies that have a growth dynamic of their own, a characteristic that makes them less exposed to the economic malaise that has hit the country, he says. One example is Lojas Renner, a retailer, which has managed to skip the consumption hangover of the past few years. Zitelmann pointed out that the company has a focused strategy, implemented by a reliable management team, which has enabled it to increase market share. As a result, sales on a same store basis, a common benchmark for the retail sector, went up by 17% in the fourth quarter of 2014.
“Renner has been growing significantly faster than the retail sector as a whole thanks to good execution of its strategies and high quality management,” Zitelmann says. The fund also seeks opportunities in areas in an early stage of development in Brazil and whose penetration in the economy looks set to swell in the near future. For instance, BB Seguridade, an insurer that makes use of its access to the banking network of Banco do Brasil to grow in Brazil’s fast growing insurance market. Or Cielo, a manager of credit cards, which has benefited from the popularization of plastic money as a means of payment.
Liquidity rules
By April, both equity funds had significant allocations to cash-like investments, a decision that is hardly a surprise in times of economic uncertainty. But Andrade argues that the cash allocation is a stock-picking decision, rather than a defensive one. Finding good stocks is a laborious job and the fund wants to have the capability to jump at the right opportunities when they are spotted in the market.
“We invest on what we know,” he says. “We can certainly miss some opportunities because we do not know the stocks very well. But we are also enhancing our knowledge of companies on a daily basis to take advantage of ever more opportunities.
“Our focus is to invest in equities. But not at any price.”
Zitelmann, for his part, says that one of the difficulties for the management team is to stick to the philosophy, even when it does not allow for taking advantage of apparently booming areas. But he notes that caution and a focus on quality have their rewards over a longer horizon. The fund avoided diving into the oil and gas sector, for example — even when it was the place to be after huge hydrocarbon reserves were discovered in the 2000s. The decision looks wise today, although for a long time some could have said it was a missed opportunity. “It was difficult to ignore the hype and all the talk about creation of value and so forth,” Zitelmann says. “It was a challenge, but we had to keep faith on our strategy, as it pays in the long run.” LF