At $23.7 billion, Brazil’s industry represents only a couple of decimal points of the more than $1 trillion under management in hedge funds worldwide. However, it accounts for the bulk of this type of investment in Latin America.
There are 109 onshore funds in Brazil, and 97 offshore, earning an average annual return of 26.44% and 17.78% respectively, according to data provider Eurekahedge. Offshore funds manage three-quarters of the money, and have experienced the biggest growth, raising more than $8 billion in 2005 alone.
Strategies exploit Brazil’s diversifying capital markets, from going long/short on equities on the fast-growing Bovespa stock exchange, to arbitrage of price differentials on the same security on and offshore, to betting on the continuing depreciation of the dollar against the real.
Started in 1994, Hedging Griffo’s $1.7 billion Verdas Fund is the oldest in Brazil. According to head of investment Luis Stuhlberger, the real competition for hedge funds is the extremely high domestic interest rate, the selic, of 18%. It has made the wealthy families and individuals, who represent around 90% of assets in Brazil’s onshore funds, highly risk averse. “High net worth individuals can go to any bank and invest at government rates, so it’s always our goal to beat that.” Verdas’ returns have beaten the selic for nine of the last 10 years.
However, the industry recently extended the notice required for investors to redeem their funds up from one day, to a 30- to 90-day standard, providing some stability. As interest rates come down, the industry expects Brazil’s state pension funds, with assets of $120 billion, to become major clients.
Other strong names in the business are Maua and Gavea Invetsimentos, founded in 2003 by Arminio Fraga, former Central Bank President. After losing momentum for the five years following the Asian crisis of 1997, the industry has experienced growth in onshore funds that long/short equity on Brazil’s rejuvenated stock market, and all types of offshore fund.
Offshore funds can afford to invest in new securities, and some see themselves as pioneers in growth areas underserved by domestic capital markets. They are also less regulated. While onshore funds must post a daily net asset value so investors know exactly how well or badly they are doing, investors must also open an account with a Brazilian financial institution to register the investment with Banco Central do Brasil. On the other hand, less regulatory oversight can mean less information for investors about their true exposure to risk.
Capitania Fund, headed by former Bank of America head trader Amaury Junior, has received institutions from Switzerland, the UK and US among others. “The benchmark for our investors is zero or Libor,” said head of investor relations Flavio Cagno.
The strongest interest from overseas investors has been in its $136 million asset-backed fund, launched only in June 2005. It invests mostly in securitized loans to small- and medium-sized agricultural producers, and also consumer loans and mortgages.
Brazil’s agricultural exports are growing much faster than the rate of growth of savings, according to Cagno, while the state-owned Banco do Brasil is “restricted” in how much it can lend, and who to. So, Capitania’s experts fly to ranches in the agricultural interior, to identify credit-worthy farmers. The Brazilian subsidiary of an Israeli security firm steps in if there is any risk of fraud.
Hedging Griffo’s flagship Verdas Fund not only escaped the losses of the Asian crisis, it profited. “We bet against emerging markets futures,” said Stuhlberger. The multi-strategy $1.7 billion fund invests mainly in external debt and commodities, and Stuhlberger, like many other pioneers of the industry in Brazil, eschews complex quantitative modelling. “Some fund of funds do mathematics and graphs,” he said, “or they try to follow trends”. These techniques are useful for short-term day-trades that bet on the momentum of a security or currency. “I’m more about fundamentals, more long-term oriented”.
His tips for cheap stocks to go long on include Petrobras and, particularly, Banco do Brasil. “Banco do Brasil has made huge provisions to clean its balance sheets of bad loans to agriculture. So they’re suffering poor earnings just now. But they just want to get it off their books before selling stocks to gringos”.