as rates in Brazil plunge, the country’s hedge fund managers are buying riskier assets. But are investors ready?
Brazilian hedge fund managers historically haven’t had to work that hard to earn good returns. They have used the country’s sky-high interest rates as the basis of their investment strategy, often effortlessly outperforming equity markets as rates were in the double digits. But since August of last year, with rates having been slashed to single digits, investors are starting to question this strategy. They are demanding that hedge fund managers invest in riskier assets — from corporate bonds to equities — to bolster returns. This change has the potential to transform the hedge fund industry in Brazil — that is, if inflation, a constant worry in the country, does not force a retreat from the lower-rate policy.
The vast majority of Brazilian hedge funds, holding over 95 percent of these riskier assets, are multimercado funds — the name for any fund that can invest in more than one asset class. They have traditionally followed a fairly simple formula for success, dubbed the “Brazil kit”: They invest the majority of their assets in domestic fixed-income securities, then throw in a dash of currencies, overseas bonds and domestic equities for good measure. It is a low-volatility strategy, but also a lucrative one because interest rates have been so high. But with the Brazilian Central Bank slashing rates, the easy money days may be over. Overnight rates in Brazil are now 8 percent, compared with 12.5 percent in 2011. While that drives up the price of managers’ existing bonds, it also means that new bond purchases will now offer lower yields.
This is the start of an article that looks at the development of Brazilian multimercado (hedge) funds. To see the full article, please go to Institutional Investor's website (www.institutionalinvestor.com).