Brazil – Turning point for equity culture?
When real rates are high, it’s easy to keep your clients happy. This will result in a wider dispersion in returns, as investment managers begin to demonstrate their worth. This is the turning point for equity culture in Brazil – the job just got more complex!
The global financial sector is full of professional people trying hard each day to do a good job for their clients. It can be a maelstrom of news headlines, from corporate, sector and industry specific, to macroeconomic to geopolitical in nature and it results in enormous flows of information. This then has to be analysed and evaluated, before interpretation and, potentially, action taken. Naturally, the focus is drawn to certain high-profile issues and occasionally less eye-catching developments can slip through the net. One of these is the good news story around the growth of equity investing in the Brazilian asset management industry.
Brazil is a country that has experienced most of the economic scenarios students learn about in their economics classes. Most citizens can still remember when inflation was a problem. Although it peaked in 1990 at 2,947%1, it wasn’t until 20042 that it fell (and remained) below double figures. Back in the early 1990s, shopkeepers would alter their prices twice a day. People were being paid twice a week, to afford the food prices at the shops.
Wages, rents, pensions, all were indexed to inflation. Brazilians preferred to take the bus than the taxi, because you pay for your bus ticket up front. In a taxi, the driver would take out a calculator at the destination and tell you how much more you had to pay, over and above what the meter said, because of the prevailing rate of inflation.
The chart below tracks headline inflation and interest rates.
Brazil Annual Inflation and Interest rates
Source: OECD as at 24 October 2019. Inflation (CPI) (indicator). doi: 10.1787/eee82e6e-en. Logarithmic scale used.
Since 2004, headline inflation has remained in single figures, taking a notable turn downwards when the recession hit in 2015/16. The September 2019 level of 2.89%3 represents an historic low, which has driven market expectations of interest rates down, to levels of 4% to 4.5% by December 2019. As always in emerging markets, the biggest beneficiaries of falling (and stable) inflation are the people at the bottom of the socio-economic ladder; unlike the wealthy, they are uniquely ‘unhedged’ and should feel the improvement in spending power very quickly. This development bodes well for the lower end consumption plays in Brazil.
The equity phenomenon
Meanwhile, the Brazilian asset management industry has been growing apace. Partly due to legislation changes over time and partly due to economic growth, assets under management breached $1 trillion in 2018, hitting $1.1 trillion in June 2019. This represents a compound annual growth rate of 144% over the last 10 years.
Domestic AUM US$ vs Equity AUM US$
Source: ANBIMA Investment Funds Bulletin as at 30 September 2019. All data in US$.
Alongside this exponential growth rate in assets under management, the corresponding numbers for investment in domestic equity has kept pace. Assets invested in the Sao Paulo stock exchange in 2000 were $19.5bn. As at June 2019, the number was $128.8bn4.
Effectively, Brazilian investors, who have grown up on a diet of high real interest rates relative to the rest of the world, are now faced with a novel choice: Get used to lower returns or diversify. They’re choosing to diversify, by increasing their allocation into equities.
One group of investors who appear to have missed this development are foreign investors.
Dedicated Emerging Markets investors are currently at a moderate (1.4%) overweight5 compared to the MSCI EM index position of 7.55%6. According to Morgan Stanley Research7, this weighting is below the 5-year average of +1.6%, let alone the maximum of +2.3%. Whilst not a demonstration of international investors’ lack of interest in the Sao Paulo Bolsa, it seems to indicate that there is room for higher allocations.
One potential catalyst could be the passage of the pension fund reforms in the Brazilian Senate, which happened on 24th October. Investors now begin to attach credence to the projected tax reform, involving a unified federal VAT rate, which would be incrementally positive for the government’s fiscal outlook.
The latest data from the Brazilian Financial and Capital Markets Association suggests that domestic equity flows are $11.7bn8 for the first nine months of 2019, with $1.8bn in September alone. Foreign investors have probably invested a fraction of that amount.
Brazil is relatively well placed in the ongoing US-China trade war – its soy bean farmers have been standout winners for the last two years, as the $15bn annual US exports to China have been switched to Brazil and to a lesser extent, Argentina. Furthermore, President Bolsonaro’s first State visit to Beijing (on the same day that pension reform passed in Brasilia) demonstrates the value placed on a good China relationship. No coincidence that Huawei has not been barred in Brazil and the company has committed to open an $800m factory in the country, to produce 5G base stations. An opportunity reveals itself.
1Source: FactSet and OECD as 24 October 2019.
2FactSet and OECD as 24 October 2019.
3Source: Banco Central Do Brasil as at 24 October 2019. https://www.bcb.gov.br/en#!/c/news/
4ANBIMA Investment Funds Bulletin as at 30 September 2019
5Source: Morgan Stanley Research, Weekly Fund Flows, 18 October 2019
6Source: MSCI as at 30 September 2019. MSCI Emerging Markets index.
7Source: Morgan Stanley Research, Weekly Fund Flows report 24 October 2019
8ANBIMA Investment Funds Bulletin as at 30 September 2019
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Investment Management Limited (‘MCIM’). It does not
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