"In the future, 2013 will be seen as a turning point in the cycle that followed that of 2008," says Alexandre Gartner, HSBC’s investment director of private banking in Brazil. "Ever since we went into the crisis, the whole world has been in a single mode of monetary easing and the relative outperformance of emerging markets to developed markets. In the second half of last year the markets departed from this reality and the reversion of this monetary stimulus will have a very significant effect on how people perceive their investments. The [investment] stories that worked in the past few years won’t necessarily work in the future. Geographies will change at different speeds and will have an important effect [on investment portfolios]. And in 2013 – especially the second half – investors woke up and began to try to get more exposed to global products and opportunities."
Regardless of the accuracy of Gartner’s prediction about how economic historians will view 2013, geographical diversification took a grip in the psyches of Brazilian private banking clients last year. Not since 2002 – when left-wing president Luiz Inácio Lula da Silva won power – has the industry experienced such momentum in money being sent offshore (although since 2002 the CVM regulations have enabled Brazilians to get exposure to international assets and currencies through onshore vehicles).
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| Marco Abrahão, head of Credit Suisse Hedging-Griffo Private Banking in São Paulo |
Some market participants, though, trace the origins of the 2013 shift abroad to the fourth quarter of 2012. Marco Abrahão, head of Credit Suisse Hedging-Griffo Private Banking in São Paulo, says: "Since 2003 our wealth generation has been kept locally. Until the end of 2012, when there were lower interest rates [Brazil’s Selic hit a low of 7.25% in late 2012 before beginning to rise in the second quarter of 2013] and a different outlook for Brazil – there was a lot of information regarding the fiscal debt in Brazil and some headwinds from the US and the talk of tapering. And there was also the devaluation in the real, which started the year [2013] at R$2 to the dollar and ended up close to R$2.40."
Domestic staple asset classes also performed badly, many for the first time in a long while. Real rates products (floating, inflation-linked notes) gave back a lot of their outperformance generated in recent years in 2013. Real estate had a tough year; real estate investment trusts performing particularly badly. Equities again had a poor year and while there was an amazing performance from many active managers during this time – many matching CDI with absolute return, which is impressive alpha generation in a falling market – in general the multimarcados had an average year at best. Challenging domestic returns looked even worse when considering the exchange rate impact.
Renato Cohn, partner and co-head of wealth management at BTG Pactual, reinforces the theme. "For a very long period here in Brazil, as the local economy was growing much faster than the developed markets, most of the money stayed here," he says. "We had a strong real and the whole market was very profitable during 2013. It was a year of a lot of changes: the currency came from R$1.70 to R$2 [to the US dollar] in 2012 and in 2013 from R$2 to R$2.40. The depreciation was very fast, and not many clients took advantage of that, but if you look at the longer-term diversification in terms of assets, it makes sense we think. We will have a much more balanced world in terms of growth, and we have been recommending clients to look at regional diversification in asset allocation – not because of the currency but because of [the likely benefits of] a balanced portfolio."
But if Brazil’s rich have finally bought into the need to diversify into foreign assets and currencies, the execution still needs work. João Albino Winkelmann, the head of Bradesco Private Bank, says that last year was a record one for sending money abroad: "We hadn’t seen that kind of movement since 2002 when Lula was elected and a lot of Brazilians got scared," he says, although he adds that 2002’s flows were substantially larger than those witnessed in 2013. "We have to learn that global diversification is a part of life and do it on an ongoing basis. Brazilians still send money abroad only when they are scared and when they see turmoil or when they feel there is political or economic instability. That’s when they think they should have 10%, 15% or even 20% of their portfolio in hard currency and they don’t care about the exchange rate. In fact, they like [buying] expensive dollars, and then when the dollar falls a bit they relax and only react when the currency goes back up."
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| Alexandre Gartner, HSBC’s investment director of private banking in Brazil |
Private banks have been advocating geographical diversification and pitching products to meet this growing demand. HSBC, for example, launched two proprietary funds based onshore that invest in global bonds and equities: one is 60% fixed income and 40% equities and the second split 80/20 over the same asset classes. The investments are global and the currency exposure is unhedged (with weekly reporting in local currency), and because the fund is aiming at diversification for Brazilian investors the exposure is more skewed to developed markets than emerging nations. Gartner says the interest has been strong, despite the R$1 million ($426,700) minimum investment (as stipulated by regulator the CVM for these kinds of investments). Cohn says that BTG Pactual’s wealth management has diversified through its Global Emerging Markets (Gem) hedge fund, which invests in the mortgage and credit markets in many countries in eastern Europe, southeast Asia and Africa: of the $5 billion invested in the fund R$3 billion is from wealth management clients. Cohn also says the bank and many of its clients are positive on opportunities in developed markets, such as US equities: "We still like US equities even though they had a great year in 2013," says Cohn. "Everybody keeps saying they are at record levels – which is true – they are at 1,800 points, but let’s remember that they were at 1,500 10 years ago, so it doesn’t mean that 1,800 is a lot. Maybe we are at the beginning of a stronger cycle and there are some technical reasons – the companies have lots of cash and are doing buybacks [to support the view of continued growth]. We are neutral US fixed income – it had a very bad year last year but we don’t think we will have another bad one. And we like hedge funds in the US – they always generate value. There are always some years that are not good, but in general we like their value proposition."
If geographical diversification is a revolutionary new rule of investment for private banking clients in Brazil then the appetite for active management is becoming almost as widely accepted, albeit having evolved more gradually. Sylvio Castro, co-chief investment officer of Credit Suisse Hedging-Griffo Private Banking, points to both themes.
"We believe a global equity diversification strategy [rather than focusing on the US] gives our clients more flexibility," he says. "We are not going to purely beta plays, we prefer active managers. We give those managers the flexibility to be in the currency and country that they think has the better alpha potential."
CSHG also prefers active managers in the local markets, many of them long-bias managers who managed to book strong returns in a falling market.
"It’s amazing how the managers in our platform performed in the past year – no one could have expected it in such a poor environment for equities," says Castro. "But what I can tell you is that when we talk to the managers we see mixed feelings. On one hand they continue to be confident in finding interesting stories – and with all this downtrend [in equity valuations] they continue to see some opportunities popping up. But at the same time from a beta perspective those guys have never had so much cash." And despite the falls in Brazilian equity valuations and price to future earnings multiples, Castro thinks the asset class doesn’t offer value: "You have to bear in mind that there is a strong downward trend in ROE and earnings growth," he says. "We still see price to forward earnings and price to book at reasonably expensive levels and so we continue to stay on the sidelines waiting for a better entry point in the local market." International valuation offers value, according to Castro, not least because "the real still needs to devalue to cope with some of the loss of productivity we have seen in Brazil in the last few years."
Domestic fixed income continues to be strong. When the Selic hit 7.25% with inflation over 6%, the total return after tax was close to zero. That prompted clients to move away from CDI-type investments and increase tenor and duration. Clients started buying corporate paper – albeit very high-quality paper with name recognition. Tax-free investments, such as those linked to agriculture (CRAs) and real estate (CRIs) continue to be popular, and now infrastructure-backed paper is finding demand. Recent deals from Vale and Petrobras, which have issued inflation (IPCA) plus 6% to 6.5% coupons offer value to all those who expect Selic to peak soon (currently at 10.5%).
"These are tax free and have very good credit risk so we have been advising clients to use these opportunities to diversify their fixed-income portfolios," says Charles Ferraz, chief investment officer at Itaú Unibanco’s wealth management group. It’s not always easy though to get clients that have been almost exclusively used to sovereign or quasi-sovereign credit risk to begin to diversify into corporate debentures – even when the private banker recommends that the reward is an excellent return for the risk. "Our experience shows that even when you have a very good risk-adjusted return, if you have a [company] name that is unfamiliar the client tends not to buy them."
And how do clients go about pricing liquidity risk for these new longer-tenor instruments in a market with little secondary trading?
"Investors tend not to price liquidity risk," says Ferraz. "That’s something that when we analyse an investment we always take into account – even when the client is proposing to buy to keep to maturity – but usually a client doesn’t price this and sometimes the market goes for a particular deal when it pays nothing on liquidity risk."
