Young Kim, Brazil head of the South Korean asset manager Mirae, is watching the remake of a fondly remembered movie. The scriptwriter is the monetary authority and the star is the interest rate, a character molded by the conditions of the economy. Twelve years ago, the Asian Tigers were suffering a tremendous crisis, which the South Korean central bank fought down at the cost of vicious blows to the returns on government bonds. South Korean debt bonds (KTB), which used to pay 35% a year, lost attractiveness until they dropped to 5% in 1999. A few years of stability in the basic interest rate were enough for Mirae – an asset manager created in 1997 and specializing in the equity market – to become the largest in the Korean market with about US$ 60 billion under management.
The only thing different about the remake is the setting. Now the story is set is Brazil, where Mirae began to operate last year. "There is enormous potential for equity management", says Kim. According to information provided by Mirae, the world average investment in stocks is about 40% of total savings; in Brazil this proportion is four times smaller. The situation stems from the history of Brazil’s basic interest rate, which has always been high. Exactly ten years ago, Brazilian bonds offered a 39.4% return for 12 months. It was as if domestic investors had a "divine right" to high rates of return with high liquidity and no risk. But the situation has changed. In June this year, for the first time since 1996 (when the Selic interest rate began to be defined by the Central Bank’s Monetary Policy Committee, or Copom), the Brazilian basic interest rate dropped below the two-digit range and was set at 9.25% per annum. People wanting robust returns will have to take risks, to the joy of bolder investment fund managers.
It's true that the Brazilian Central Bank's report on market expectations, the Focus Bulletin, predicts that the Selic will rise in 2010. But that isn't changing the optimistic scenario expected by stock investment funds (FIAs), private equity funds (FIPs), hedge funds and even credit rights funds (FIDCs).
"Brazil has reached a new level", says André Lion, an equity manager at BRZ Investimentos, for whom the exorbitant returns of government bonds will become a thing of the past. The economic policy implemented since the onset of the Plano Real, in 1994, allows Brazil to pay less for its financing needs, without inflation running out of control. BRZ is forecasting an even deeper cut than calculated by the Central Bank's Focus report. According to the asset manager's analysis, the Selic will be 8.25% by the end of 2009. But the most important moment took place in 2007, according to Lion. In September of that year, the Copom set the interest rate at 11.75%, breaking a significant threshold. "Investors who put their money into a standard investment would receive less than 1% per month." Although the interest rate rose again in 2008, breaking the 1% per month barrier, investors had begun to view equities as more attractive.
From 2007 onward, individual investors become more and more important to the stock market. They currently account for one third of trading volume. With years of stabilization of interest rates, funds that operate on the stock market may undergo a similar phenomenon. Even though it admits that it will continue to focus on institutional investors, BRZ is expecting to raise funds from individuals for the significant expansion that it is planning. In the upcoming years, BRZ intends to increase its assets under management from the current R$ 2.7 billion to R$ 10 billion.
THE CALL OF DIVIDENDS — Mirae's experience in the South Korean market makes individual investors a natural target. About 80% of the equity managed by Mirae worldwide was raised in the retail market. Reaching the same proportion in Brazil without a distribution network will be more complicated. But the profile of the portfolios that Mirae manages usually attracts that type of investor. "We won many clients in the Korean market with funds that invested in good dividend payers", Kim recalls. The same tactics will be replicated in the Brazilian market.
Dividend funds attract new equity investors because they are less risky than other portfolios, given that they have a safety net against drops in value. A possible depreciation of the shares could be mitigated by distributing the earnings from good payers. The same rationale is also used by FIDC specialists, when they bet that increased funds will be raised for these portfolios. Even though FIDCs are not a typical equity product, their premium is always defined by the interbank deposit (DI) rate plus an additional rate. Only a small portion of the shares, known as subordinate shares, produce variable returns. "Few investments provided returns that exceeded the DI during the crisis. FIDCs were one of them", notes Carlos Lopes, a partner at finance consultant Uqbar.
Built on securitized credit rights, there are two major bottlenecks for FIDCs’ development in Brazil. Firstly, the as-yet small percentage represented by credit in relation to the Gross Domestic Product (GDP), which was 43% in May according to the Brazilian Central Bank. In more developed countries, this number easily exceeds 100%; in the United States, it can reach 180%. The other issue is harder to combat: ignorance on the part of entrepreneurs. Few use the assignment of credit rights as a way to raise funds. "And the companies that do usually confuse FIDCs with discrete operations, such as debentures", notes Pedro Lérias, a portfolio manager at Verax Serviços Financeiros. Unlike bonds, securitization can be viewed as a form of continuous fundraising for a company.
YES TO RISK, BUT ONLY IF YOU’RE PREPARED — The FIDC investor profile is basically comprised of institutional investors and is unlikely to change in the coming years, even with lower interest rates. Brazilian Securities and Exchange Commission Instruction 356, which regulates this type of funds, restricts the distribution of their shares to qualified investors. Even if this requirement were to be lifted, a change in regulations would not bring immediate results. The structure's complexity keeps it far away from the retail audience. The same could be said of private equity funds, who invest in long-term equity stakes in publicly traded and privately held companies. Their shareholders must commit their capital when the funds is started, and spend years with their assets invested there. Few retail investors are so "patient".
Risk-averse shareholders who are unprepared for low liquidity are also not good clients for asset managers. Neo Investimentos, whose portfolio includes a private equity fund, knows this well. During the second half of 2008, it saw its equity drop by half — from R$ 1.1 billion at the start of 2008 to R$ 520 million in the course of the year. "We tried to show the shareholders that it wasn't the right time to bail out, but to no avail", recalls Henrique Alvares, managing partner at Neo. The stampede had the harshest effect on hedge funds, which usually invest partly in fixed income, and partly in the stock market. And it's precisely these funds that are expected to grow the most in the upcoming times of low interest rates.
"It will be the big test of suitability ", notes Lion from BRZ. The term suitability is used to characterize the effort made by investment houses to adapt their products to investors' risk tolerance. One of the causes for the mass withdrawals suffered by the industry during the crisis was precisely this lack of a fit to shareholder profiles. Investors were not prepared to see the value of their shares go down, hand-in-hand with the stock market indexes. The suitability pointed out by Lion would probably have helped to avoid such mass withdrawals during the downturn.
In July, the Brazilian fund industry will take an important step toward suitability: all asset managers will have to certify to the National Association of Investment Banks (Anbid), the fund industry's self-regulation entity, that their distributors implement the necessary methodology to fit their investments to investors’ risk profiles. The requirement was issued in August 2008 and, since then, distributors have taken it upon themselves to develop this methodology.
Coremec recommends suitability
In the final week of June, the Regulation and Enforcement Committee for the Financial, Capital, Insurance, Pension and Capitalization Markets (Coremec) recommended to all entities within its jurisdiction that they implement standards aiming to fit investment risks to investor profiles. The Coremec is comprised of the Brazilian Central Bank, the Brazilian Securities and Exchange Commission (CVM), the Private Insurance Superintendence (Susep) and the Secretariat of Complementary Pensions (SPC). No deadline was defined for implementing the rules.
According to CVM director Otávio Yazbek, the crisis has made it clear that investment risks must conform to investor profiles. "The agents of these markets will also be better protected, along with investors." Upon identifying their clients' risk profiles, managers, insurers, pension funds and intermediaries will be forced to find out more about their products.
The CVM will be in charge of investment offerings by banks, brokers and distributors. Given that the self-regulation headed by the National Association of Investment Banks (Anbid) is well advanced, the CVM intends to publish a more generic rule. The CVM will issue only three directives to the Anbid: concrete rules, effective application and enforcement, and rendering of accounts to the CVM.
The Coremec, a sort of advisory board, has decided to extend suitability to various markets as recommended by the CVM. In April 2007, the CVM placed under public hearing a draft aiming to establish parameters and evaluation duties within the capital market. The conclusion was that such a rule would have to exist in the various regulated environments at the same time. "If there is suitability in only one market, all you need to do to evade the rule is issue products elsewhere", says Yazbek.
The study that grounded the Coremec's decision, produced by the Basel Committee on Banking Supervision, divided institutions into five categories (asset managers, banks, consultancies, insurers and brokers) and investments into 21 types. (M.L.)
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