A focus on quality securities, currency plays and conservative approaches has paid off for fund managers in Brazil as they face the country’s worst recession in decades.

But some of the factors that drove performance in 2015, such as bets on the dollar and on foreign equities, will be hard to replicate in 2016 given that global markets also cooled off in the first quarter of the year.

The challenge to deliver performance is particularly relevant for funds that focus on riskier assets, as Brazil’s political and economic deterioration has spooked investors who are fleeing investment funds in droves.

According to Anbima, an association of financial companies, the fund industry registered 424.4 billion reais in redemptions in 2015, compared to 411.3 billion reais of sales. Brazilian hedge funds, known as multimercados, suffered the biggest hit, with redemptions surpassing sales by 32.8 billion reais. Around 18.7 billion reais left equity funds, while fixed income ones posted a net loss of 14.8 billion reais. A similar trend was observed in the first two months of 2016.

Investors are taking their money out of even the best performing funds. According to LatinFinance’s 2016 Funds Scorecard Ranking, the Bradesco FIA Bdr Nivel I delivered returns of over 125% in reais in the past three years. The Scorecard measures performance over one and three years to April 15, 2016, based on data from Economatica. Bradesco’s good showing, however, did not stop redemptions overtaking sales by almost 190 million reais in 2015. In 2016, until mid-March, redemptions reached 73.3 million reais, compared to 17.2 million reais worth of sales.

According to analysts, Brazil’s dire economy, which is projected to contract by more than 3% this year after shrinking by 3.8% in 2015, is driving investors to avoid risk as much as they can. Add to that the country’s chaotic political situation, and it is not really surprising that a flight to safety is the main theme for investors these days.

“Brazil is going through a perfect storm of political and economic conditions,” said Lywal Salles, a board member at Vinci Partners, an investment and advisory firm. “As a result, ‘doing nothing’ has become an option for many investors.”

Sandra Petrovski, chief investment officer at Votorantim Asset Management, says investors are turning their attention to “the good rates” offered by fixed income. “I believe this will be the trend for the remainder of the year,” she says.

Equity funds that have fared well have strived to avoid the pitfalls of the Brazilian economy by looking abroad or focusing on quality over bargains.

For instance, the Bradesco FIA Bdr Nivel I fund is 100% invested in Brazilian Depositary Receipts, BDRs, which are securities sold in the São Paulo Stock Exchange by foreign companies.

It invests in around 50 American blue chips such as Google, Apple, Microsoft and Wal-Mart. As a result, in the past few years the fund benefited from both the rally of American stocks and the depreciation of the real against the dollar, said Ricardo Almeida, the head of equities at Bradesco Asset Management, BRAM.

“Performance was boosted by the good trajectory of American equities, but also by the currency exchange,” he points out. Since the launching of the fund, in late 2011, the value of the real has halved compared to the US dollar.

The BDR-based fund was at first offered only to qualified investors, but since the CVM, Brazil’s securities commission, changed the rules for investment in funds last year, the company has also targeted retail investors.

“We like to offer our clients the possibility of diversifying their portfolios,” Almeida says, noting that BRAM also offers equity funds focused on Europe, Japan, Asia and Latin America. “For the investor, it is an intelligent way to mitigate the portfolio risk. These funds offer an interesting currency exposure and the possibility to invest in sectors that are not very developed in the Brazilian stock exchange, such as technology.”

The challenge for the fund is to carry on delivering results even as the American market looks less bullish and the real stops devaluing, which is likely to happen if the Brazilian economy reaches some kind of normalcy.

“We are a little worried about the US labor market,” Almeida says. “Even though revenues have not been outstanding, American companies have been able to increase their margins thanks to technology and innovation. Now the labor market is tight, workers tend to demand higher wages, and it could put pressure on margins.”

But, by focusing on American stocks, the fund has taken a road that has proved the best choice for equity investors in Brazil of late, says Fernando Lovisotto, a director at Vinci Partners. “The funds that are the most detached from Ibovespa have fared much better.”

That means avoiding securities that constitute a large share of the index, such as Petrobras and Vale, which have taken a dramatic fall due to both Brazilian and global trends. Another option is concentrating investments on a few, reliable stocks, he says.

Concentration is one of the factors that explain the positive performance of BTG Pactual Absoluto FIC FIA, the sixth-best performer in the three-year period in the equities fund category. José Zitelmann, the head of Equities at the BTG Pactual’s asset management unit, says the five largest holdings of the fund amount to over 50% of its assets under management.

Another pillar of the fund’s strategy is that it only invests in companies that its managers know thoroughly, he says. And it also tends to look for quality stocks, even if they are not among the cheapest securities around.

“We look for winners, even if their valuation, although attractive, is higher than some of their peers,” Zitelmann says.

One example is Lojas Renner, a retailer that for a long time has been a darling of equity investors in Brazil. “Retailers performed poorly last year, but not Lojas Renner,” Zitelmann said. “They did well in terms of the value of the stock, but also on the operational side. Same store sales increased by double digits, while its rivals were reporting drops.”

He added: “We tend to focus on factors that we can have control over. Factors such as execution, customer service. In difficult times, companies that do things well will outperform.”

Another of the company’s funds, the BTG Pactual Absoluto LS FIC FIA, ranked third in the equity scorecard by adding a hedge-fund element to the mix. A share of the assets is kept on holdings in a very similar way of its namesake, Zitelmann explained. But another share is employed to short and long stocks where the managers identify a significant trend.

Last year, for example, it shorted Vale, and the bet paid out nicely when the stock dropped dramatically as the mining giant suffered with the woes of the global commodities sector. “It works almost as a hedge fund,” Zitelmann said. “We keep 30% to 40% of the money in stocks that we like, and the remainder is employed for long-short strategies.”

The fund also invests outside of Brazil, largely in the US and Mexico, which has added a currency element to its performance. This has also been the main factor behind the performance of multimercado funds that did well last year, analysts said.

“Last year, multimercados benefited from bets on the dollar. Strategies that focused on higher interest rates did well too,” says Ricardo P. Câmara Leal, a professor of finance at the Federal University of Rio de Janeiro. “In 2016, however, things look more difficult. Many managers believe the currency market will remain volatile, but without a clear direction. And the political situation is very uncertain. Especially for macro funds, the environment looks difficult, and that could frighten investors further.”

Many of those who are fleeing from riskier funds are flocking to fixed income alternatives. For example, the Vot FI Premium Banks RF Cred Priv, a top ten performer in the past three years in the fixed income category, has more than doubled in size during the past two years, when Brazil’s situation took a sharp turn to the worse.

“This is a very conservative fund,” Petrovski said. She explained that it invests in private debt, and mostly on securities issued by financial institutions, such as the so-called Certificados de Depósitos Bancários, CDBs, and Letras Financeiras, LFs. The goal is to match the performance of the Central Bank’s interbank deposit certificate rate, known as CDI from its Portuguese initials, adding a little premium on top. In the 12 months to mid-March, it delivered almost 106% of the benchmark.

“Although we focus on securities with very low risk, we believe that the market often exaggerates the premium or the punishment attributed to some bonds,” she explained. “So we also try to identify papers where the premium paid by the market is too low for the risk offered, and we avoid to buy them.”

Even funds that employ less risky strategies have to tiptoe in times of extreme economic distress, such as the current environment in Brazil. In fact, Brazilian media has started to report cases where the fund portfolios of some asset managers have suffered with credit events that affected structured products such as Fundos de Investimento em Direitos Creditórios, of FIDCs, a money raising vehicle much-used by Brazilian companies.

Jean Pierre Cote Gil, credit portfolio manager at Western Asset Management in Brazil, noted the difficulties that issuers have to deal with today can even generate some opportunities for fund managers. That is the case with the Western Asset Prev Credit RF FI Credpriv, which ranked third in the category in the three-year period.

“We have been able to renegotiate prices and conditions for some operations, to the advantage of the fund, when issuers cannot meet, for example, a financial covenant that had been agreed,” he says. But he added that the priority today is to avoid nasty surprises.

“We are following very closely the performance of companies, as well as the trends for each business sector,” adds Gil. “As there is little liquidity in this market, volatility is sometimes not spotted by investors until the prices start moving, giving the false impression that credit risk is low,” Gil remarked. The fund’s allocation includes about one third of assets in debenture bonds, and about the same amount in Letras Financeiras, with a little share of about 5% of FIDCs.

Since last year, with the deterioration of the economy accelerating, the fund has become ever more selective of the bonds it acquires. As a result, the cash position has increased as well. “Private credit securities in Brazil have, in general, shorter terms than in other countries like the US. Therefore, if you reduce the frequency of purchase of new bonds, the cash position increases naturally,” he pointed out.

“Our cash positions reflect not only a cautious approach, but also our desire to take advantage of new opportunities as they come,” Gil adds. “And we are beginning to see more interesting opportunities now than four or five months ago.”

Larger cash positions are a common feature of many investment funds in Brazil, as keeping money in liquid bonds issued by government is not a bad idea in times of high inflation and stratospheric interest rates. Some of this money could start coming back to equities and multimercado funds once Brazil’s political situation improves. “We have actually started to hear from investors that their equity positions are too low at the moment,” Lovisotto says.

But while redemptions continue to surpass sales, it is a matter of identifying which funds will get out of the current rough ride in a single piece.

“Investors are very impatient in Brazil, where opportunity costs are too high,” Leal says. “With interest rates over 14%, it is hard to keep the money on multimercado or equity funds that are not performing too well.”

He believes that, as a result, the fund market could consolidate in the near future, with funds merging as their assets under management shrink. “When the economy was growing strongly, many new funds were created in the country, and the immense majority of them are not doing well.” LF