Brazil: Window Opens for International Managers |
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October 2010 |
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Welcome
Richard Ernesti
Managing Director, Global Head of Client & Sales Management for Investors
Global Transaction Services, Citi
Brazil is the world's eighth largest asset management market with upwards of US$800 billion of invested assets. Hitherto, the great bulk of that money has been tied up in the country's domestic bond and equity markets. In this issue of Spotlight we look at prospects for a shift in direction of Brazilian investment flows and the opportunities now presented for international asset managers seeking to penetrate this important and significant market.
In the past two years Brazil has witnessed two major regulatory changes which, for the first time, have paved the way for registered investment funds, high net worth investors and, above all, pension funds to invest abroad. As a consequence, the need to establish a presence in Brazil has assumed greater priority among international asset managers.
While a steady stream of US, European and, increasingly, Asian firms are establishing a presence in Rio and Sao Paulo, the signs are they will need to be patient. For the time being, high domestic interest rates make Brazil's bond markets an attractive, low-risk haven for local investors, both large and smaller scale – a situation that looks unlikely to change in the near future.
We also take a look at moves the Brazilian authorities are making to expand and internationalise their own capital markets, and how they plan to capture at least a proportion of the anticipated outflows.
Pension funds hold the key
Marcio Veronese
Director, Brazil Client and Sales Management
Global Transaction Services, Citi
In recent years, Brazil has been viewed by international asset managers primarily as an investment destination. Strong growth, a steady improvement in credit standing and an appreciation in the Real have all underpinned Brazil's status as member of the elite 'BRIC' club of emerging countries. After a relatively resilient economic performance in 2008/09, Brazil reported net portfolio investment of $13.5 billion in 2009.
Now however, Brazil is beginning to look like an exciting target in its own right for funds distribution. The reason? Local investors are starting to take advantage of new-found freedoms to invest overseas.
Successive regulatory changes in the past couple of years have allowed authorised investment funds and high net worth individuals, followed by pension funds, to invest a proportion of their assets abroad. At the top end of the private investor market, the so-called 'super-qualified investors', individuals can now invest 100% of their money into an international fund – but there is a high minimum investment of R$1m (US$560,000). This new market for sophisticated investors represents a major opportunity for international asset managers. Few domestic asset managers can genuinely claim to offer expertise in international markets.
The development that has generated the most excitement in the asset management industry however is the 2009 announcement that permits local pension funds to allocate 10% of their assets to offshore markets. That may not sound like much but, as pension funds account for around half of all investment assets in Brazil, it amounts to a potential outflow of US$40 billion to US$50 billion.
Master-feeder Structures Essential
Numerous international asset managers have descended on Rio with a view to targeting these potential outflows, and more are looking to enter the market. There are a number of considerations however that international asset managers must take into account. Firstly, offshore funds cannot be sold in Brazil. Asset managers are obliged to use master-feeder structures, using locally domiciled 'international investment funds' as their feeders. In order to distribute these feeders domestically, asset managers must also register locally and are required to maintain a substantial presence in Brazil. In addition, approximately 80% of local distribution has been controlled by banks. It is important therefore that the international asset managers who choose to locate in Brazil are cogniscent of this established market practice and develop appropriate relationships and distribution channels.
The market is highly regulated, with firms obliged to provide data to the regulator on a daily basis. To minimize the initial investment, many firms are turning to third-party administrators. With a presence in Brazil that stretches back 95 years, and an established position in the local fund administration and distribution markets, Citi has been actively helping international fund managers enter the market and create local feeder funds.
Perhaps the biggest competition for international funds stems not from local fund managers but from the yields available in the domestic bond markets, and the returns achieved there in the past six or seven years. Brazil's dollar bonds have been among the best performing securities in the world as Brazil has transformed itself over that period from developing nation into economic superstar. The yield premium for holding the country's debt has fallen sharply.
This explains why half of total assets under management in Brazil are still invested in government bonds. It also explains why foreign holdings of Brazil's domestic debt have risen from almost zero to around 9% of the total stock in just four years.
Despite the strong growth in the economy over much of the past decade, domestic Real bonds still offer double-digit returns, a reflection of the ongoing battle with inflation being waged by Brazil's central bank. In the second quarter of this year – a time when central banks in the US and Europe were continuing to hold rates down at the lowest levels in history – Brazil's benchmark Selic rate was raised twice.
The effect of that? No other country has real rates as high as Brazil's. At a time when competing BRICs such as China and India are offering international investors in their government bond markets yields of less than 5%, Brazil is offering yields of between 10% and 12%.
Is Brazil Another Chile?
Taking the long view, however, Brazilian interest rates must fall. In recognition of that fact, institutional investors are already starting to look for different instruments and different markets. The hope is that Brazil will mirror the experience in Chile following a progressive relaxation of Chilean overseas investment rules over the course of the 1990s.
Over time, the relaxation moves have had a pronounced effect on the growth of the local funds market and the direction of investment flows. Chile accounted for 120 new fund registrations in 2009 and almost half of local investment in the country is now targeted at offshore assets. All the major asset managers are selling into the Chilean market. (Gene, the % that Chilean AFP's invest offshore is 43.9% as of Aug 2010, being that 22.6% out of the total is allocated into Offshore Mutual Funds)
It is already a mark of how far the Brazilian market has come that it is no longer just the top names from the US and Europe – be it asset managers or investors – that are looking to enter the local market. Asian names now figure prominently in the mix, among them Mirae Asset Management, the renowned Korean asset manager with "x" amount of assets under management. Prior to its setting up locally, Mirae already had an allocation to the country managed from London. Two years ago it established operations in Brazil.
Dual Attraction to a Brazil Presence
This local presence has achieved two goals for Mirae – improving its ability to penetrate the Brazilian market and enabling it to sell its Brazilian expertise back home in Asia. Other international firms are looking to adopt a similar strategy. The attraction of a Brazilian operation is twofold. Not only does it allow a firm to compete locally, tapping the anticipated outflow as demand for international investment expands, but it also ensures the manager is well positioned to capitalise on growing international demand for Brazilian equities. Taking a ten-year view, Brazil's economy is set to become one of the world's largest. This growth is expected to oblige institutional investors in OECD countries to review and increase their allocations to the Brazilian market.
Recent newcomers have hired locally to build the domestic expertise and market intelligence they need. Cost is clearly an issue here and the Brazilian regulator insists that firms establish a full presence in the local marketplace if they are to be allowed to distribute locally. For a number of firms, the solution is to leverage Citi's existing investment in people and systems and outsource their local administration requirements to Citi. An alliance with Citi delivers the very best in back office and distribution support while minimising a firm's up-front investment in the country.
Brazil may be a 'slow burn', but taking a three to five year view it offers immense potential as a target market for international funds distribution. The development of local expertise will also prove rewarding in a larger context as international investors increasingly turn their attention to Brazil's economic growth potential. The key is to enter the market in a cost-effective manner. With its long history in the country and its highly developed local securities services expertise, Citi is ideally positioned to assist international asset managers in making their Brazilian aspirations a reality.
Local Market has Big Ambitions
Cathal O'Daly,
Director,
Ireland Head of Financial Institutions Group,
Global Transaction Services,
Citi
As the Brazilian authorities progressively open up the international markets to domestic investors, so they are endeavouring to bring more of the international capital markets to Brazil.
In March 2010, the Brazilian Federation of Banks, FEBRABAN, combined with the financial and capital markets association, ANBIMA, and the stock and futures markets operator, BM&F Bovespa, to form a new association called Brazil Investment and Business – or BRAiN for short. The purpose of the new initiative is to strengthen Brazil's position as a regional investment and business hub, and to accelerate the internationalisation of Brazil's financial sector and capital markets.
As part of the new approach, local exchanges are promoting the creation of Brazilian Depositary Receipts (BDRs). Investment in a BDR counts as an investment abroad and Brazilian exchanges are looking to capture some of the dealing from the outflow expected following the recent regulatory changes noted above.
Telefonica, the Spanish telecoms company, and Dufry Group, a Swiss retailer, were among the first to list local BDRs – both as a result of M&A activity. Citi has been closely involved in opening up the new market, winning the mandate to bring ten US unsponsored BDRs which started trading in September 2010.
The authorities have also been encouraging the creation of exchange-traded funds (ETFs). ETFs are seen as a critical element of the strategy to improve the local markets. To date, iShares has led the way with six ETFs launched in the past two years. Citi acts as administrator to all six.
The development of the BDR market and the creation of ETFs are both aimed at expanding local liquidity and increasing the range of instruments traded locally. The ultimate goal is to transform the Brazilian market into a worldwide securities hub. With its strong local presence and involvement in both the BDR and ETF space, Citi is playing its critical role in these new initiatives.
