After all, they argue Brazil has an upside and may carry less risk
than the other BRIC countries of Russia, India and China. Hopes that
Brazil's next president to be elected in October will rein in
spending and adjust macroeconomic policies sparked a rally in
domestic markets in the past few days.
The big question is whether Brazil's currency, the real, will sink
further and wipe out returns on real-denominated bonds. For some the
danger is modest enough to handle, especially for the sweet double
"When you look around at the local emerging market debt market,
Brazil actually looks very attractive," said Gerardo Rodriguez,
senior investment strategist for BlackRock's emerging markets group.
"There was some uncertainty in the policy mix, but now with the
central bank being more aggressive on the tightening cycle, you're
having some stability and it has been a good entry point for many
investors, especially on the long end of the curve."
Brazil's central bank on Wednesday raised interest rates for the
ninth straight time, extending one of the world's longest rate
tightening cycles after a surge in food prices added to the
country's already high inflation. Since April 2013, the central bank
has increased its benchmark interest rate 3.75 percentage points.
That has prompted some investors, who had been rushing out of the
country's equity market over concerns about high inflation and tepid
growth, to consider Brazilian bonds. Brazil's 10-year bond yields
12.8 percent in local currency, according to Thomson Reuters data,
compared with a yield of 2.79 percent for a 10-year note in the
"If you're an investor (in the Brazilian market) sitting on money,
and you're saying where should I put my next incremental investment,
the rates you're going to get in that bond market just got more
attractive," said Dave Nadig, chief investment officer at San
Francisco-based research and analytics firm ETF.com. "That's where
there's an immediate direct impact."
Investors who buy fixed income securities run the risk that
inflation will continue to cut into real returns. On March 27,
Brazil's central bank increased its 2014 inflation forecast to 6.1
percent from its earlier estimate of 5.7 percent, and raised its
2015 inflation estimate to 5.5 percent from 5.4 percent.
Those moves have come amid wide swings in the value of Brazil's
currency. Since January 2013, the value of the real against the
dollar has fallen approximately 15 percent, from 1.96 per dollar to
2.26. Should the real continue to fall, U.S.-based investors who
convert their earnings from reais to U.S. dollars will see the value
of their positions erode.
U.S. investors typically cannot buy Brazilian bonds directly unless
they put in a large order through their broker. And, with no
exchange-traded funds investing solely in Brazilian debt, analysts
say the best alternative are emerging markets bond ETFs which count
Brazil among their largest country allocations.
The WisdomTree Emerging Markets Local Debt Fund, for example, has
its third largest country allocation, roughly 10.6 percent, in
Brazil. The fund, which invests in bonds denominated in emerging
market currencies, has gained about 4.5 percent over the past two
months, since falling in late January.
For those that want to hedge out exposure to the real, the Vanguard
Emerging Markets Government Bond ETF — with its second largest
country weighting in Brazil — and the iShares J.P. Morgan USD
Emerging Markets Bond ETF, track bonds denominated in U.S. dollars.
The Vanguard fund, launched just last year, is up about 3 percent
since early February, while the iShares fund is up about 3.8 percent
[to top of second column]
GOING FOR DOLLAR-DENOMINATED DEBT
The volatility of the Brazilian real makes buying Brazilian bonds
unattractive for some investors, despite the alluring yields.
Instead, some fund managers say they are buying Brazilian corporate
bonds that are denominated in dollars rather than adding bonds
issued in the real, effectively trading a safer currency for lower
"You're just not getting paid enough to take on the risk," that
Brazilian inflation will cut the real's buying power against the
dollar, said John Lekas, a senior portfolio manager at Leader
Capital who oversees roughly $1 billion in assets among two funds.
Though Brazilian sovereign bonds carry investment grade credit
ratings, their corporate counterparts issued in dollars allow a
better way to tap into the Brazilian economy without taking a
currency risk, Lekas said.
Instead, he has been buying bonds issued in dollars by Brazilian
industrial, materials and telecommunications firms. For example, he
recently took a position in dollar-denominated bonds issued by
telephone company Oi that matures in six years and pays an interest
rate of 5.7 percent.
Jenelle Woodward, director of research at BMO TCH, which runs the
BMO TCH Emerging Markets Bond Fund, said that Brazil's rampant
inflation will likely eat into real returns. The fund instead has
been picking up dollar-denominated bonds issued by global companies
headquartered in Brazil, such as a 10-year bond issued by energy
company Petrobras that yields approximately 6 percent.
EQUITY OPPORTUNITIES FOR LONG-TERM INVESTORS
Even as U.S. investors shy away from Brazilian equities and go
towards bonds, some see long-term opportunity in the country's
stocks, which have been selling off. Brazil's benchmark Bovespa
index had fallen some 12.7 percent from Jan 1 through mid-March, but
has been on the ascent in recent weeks.
"Valuations in the equities space are starting to look attractive,"
said BlackRock's Rodriguez.
While most Brazilian stocks pay a dividend, there are few direct
ways for fund investors to focus on dividend-paying stocks. The $4.3
billion MSCI iShares Brazil Capped fund, for example, offers a
dividend yield of 3.2 percent, a level slightly less than the 4.3
percent yield of the broader WidsomTree Emerging Markets Equity ETF.
"Emerging markets are much more volatile, but if you stay invested
through the investment cycle, you can expect to get double digit
returns," Rodriguez said.
Still many say they are in no rush to get into equities.
Right now, "you're really stuck between a rock and a hard place"
with Brazil, said King Lip, chief investment officer at San
Francisco-based Baker Avenue Asset Management.
"We think it has further to fall before we see a rebound," Lip said.
"I'd rather be investing in bonds than equities right now because I
do believe eventually inflation will be controlled and they're going
to be happy to reduce rates to stimulate the economy and then bonds
are going to be rallying on that."
(Reporting by Ashley Lau and David Randall; editing by Linda Stern
and Andrew Hay)
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