Portfolios have suffered losses as the real appreciated and benchmark indexes declined
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11/03/2022
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Giuliano De Marchi — Foto: Silvia Zamboni/Valor
Brazilians embraced international diversification and allocated part of their assets to strategies unrelated with the country in recent years. Now they face a trial by fire. With the appreciation of the real and benchmark indexes like S&P 500 going south, some portfolios have suffered double-digit losses in 2022, especially those without currency hedging. The international scenario, already concerning due to the change of monetary policy in the United States, now includes a war in the European backyard with Russia’s military invasion in Ukraine. And withstanding the exchange rate and external volatility seems to be even harder at a time of rising interest rates here – the Selic, Brazil’s benchmark interest rate, went to 10.75% per year from the ultra-low level of 2% at the beginning of 2021, and there are new hikes ahead.
With such a combination, the assets of foreign asset-management firms that distribute shares through local vehicles shrank to about R$63 billion at the beginning of March from R$81.7 billion at the end of 2021, while the number of investors fell to 360,000 from 480,000, data compiled by J.P. Morgan Asset show. The reduction comes after years of strong expansion. The segment totaled R$16.5 billion at the end of 2017, with around 50,500 shareholders. Last year alone, it doubled in size after having closed 2020 with almost R$44 billion and 212.500 investors.
The movements of the Brazilian exchange rate and the S&P 500 in the first months of 2022 alone would mean a 20% drop for global funds without hedging, said Giuliano De Marchi, head of Latin America at J.P. Morgan Asset. He sees a generalized sale of risk assets driven by the Russia-Ukraine conflict, but says that the diversification of currencies and geographies continues to make sense in the long run. With the foreign exchange rate at R$5 to the dollar in Brazil and foreign assets at a discount, the moment is, in theory, more favorable than when the currency was at R$5.70 and global equities at their peak. The prevailing assessment is that the dollar will remain as a safe-haven currency, especially when the Federal Reserve sets in motion its roadmap to increase interest rates.
“There is no basis for Brazil to continue at this speed of appreciation,” Mr. De Marchi said, referring to the real and the local benchmark index Ibovespa, which have been driven by foreign capital. “There are other markets, not only the United States, with opportunities to perform as well or better than Brazil. The goal is to have diversified returns, because putting 10% to 20% in other markets helps in moments of volatility.”
Although there is no predictable outcome to the Russia-Ukraine conflict, J.P. Morgan’s thesis is that it will not fundamentally affect the growth of the global economy in the post-pandemic era. The Federal Reserve may slow the pace of interest rate increases, but the direction was given to contain inflationary pressures that tend to be potentiated by a war coupled with rising commodity prices. “China is going to continue to grow strongly. It’s a one-in-a-lifetime transformation, which is shifting the relevance of Western companies to those of East Asia,” Mr. De Marchi said. “But assets are going to face volatility. You need to have a minimum investment horizon of two years.”
The executive says that Brazilians currently prefer portfolios with currency hedging, which cushions the swings of the exchange rate. But those who buy Brazilian Depositary Receipts (BDR) on the stock exchange have pure international exposure, although they make the allocation in reais. “For the next few months, the big question mark is whether the investor will hold out. We expect withdrawals, people go through this. But the most important time to buy is during the crises of market volatility, when the assets are at a discount.”
The natural reaction of investors who made international investments for the first time is to rethink the strategy, said Marcus Vinicius Gonçalves, CEO of Franklin Templeton in Brazil. “With high interest rates, appreciation of the real, falling stock markets abroad and all the geopolitical tension, they may not understand why it makes sense to diversify. It’s a huge financial education exercise,” he said.
The executive added that despite being a difficult exercise, Brazilians cannot lose sight of the foreign market, which is a thriving one. “The opportunities are not going to disappear because of what the world is experiencing this year. The companies are not going to stop presenting good results. The perception of risk has changed, but it’s not because the return here has improved that the investor should bring his money back and leave [foreign funds].”
Although the war was something unthinkable about two months ago, Mr. Gonçalves recalled that the conflict highlights how useful is being exposed to diverse markets. “Just think about a Russian investor who had savings in the country, based on a currency that had $600 billion in reserves that were embargoed, and can’t withdraw the money.”
In this shorter period, virtually all portfolios suffered, including stocks, currencies, global fixed income and technology-related funds, the executive said. Companies based in Europe that operate in Asia had their prices revalued due to expectations of reduced consumption, such as the luxury market. Long-short funds, for instance, faced losses of 4% to 5% instead of 15% because they can short certain assets.
For those who do not have any exposure abroad, maybe it is time to set up operations without currency hedging, under the premise that the global economy will not go into recession in 2022 and that the Fed may even be less aggressive in the monetary correction process at the beginning, but will have to face inflation because of energy prices. “The global liquidity scenario can be impacted. It can have transmission mechanisms to the financial system, it has to be closely monitored not only because of Swift [the international payments chamber, from which some Russian banks were banned], but also because of banks in countries like Italy and Germany exposed to Eastern Europe.”
As much as Brazilians have made a move toward international assets, the total represented little more than 1.2% of the fund industry at the end of last year, said Daniel Celano, who leads third-party asset management at Schroders Brasil. For the investor who feels like he is missing out on the foreign capital party in the local stock market, he recalled that in order to really enter the ranks of long-term foreign investors, the country needs to start growing again. In the short term there are presidential elections and a poorly solved fiscal situation. For now, the local market is also benefiting, along with other emerging economies, from the capital flight from Russia.
With higher interest rates in Brazil, Mr. Celano says he sees demand for funds with currency hedging, but some institutional clients who had protection have fully or partially dismantled it now that the exchange rate is closer to R$5. Foundations that had not yet taken the international step, but approved the investments in committee, however, are adopting a wait-and-see approach.
Source: Valor International