December 2010

BRAZIL: shining brightly, but hardly noticed

Brazil_beachBrazil was one of 2010’s most notable markets, so Martyn Cuff, of Allianz Global Investors Europe, asks if the Brazilian asset management industry has come of age   What do Investec Asset Management, Hermes, Jupiter, Henderson and Threadneedle have in common with the largest fund managers in Brazil, namely BB-Nossa Caixa, ITAU Unibanco, Bradesco, Caixa and Banco Santander (Brazil)?

The answer is that they are companies of comparable sizes, as measured by assets under management (AuM). However, it is quite possible that not many people know a great deal about these Brazilian entities.

What is more, according to the Associação Brasileira das Entidades dos Mercados Financeiro e de Capitais (Anbima), the trade association which represents asset management and banking in Brazil, as at the end of 2009 there were around 350 asset management companies managing a total of R$1.5trn (approximately €670bn). Globally, this puts the Brazilian asset management industry seventh in terms of size.

Therefore, in asset management terms, Brazil is already ‘on the map’. Beyond this, there seems to be a certain general buzz around Brazil which is hard to ignore. This is for various reasons, such as:
  • Hosting of the 2014 Football World Cup;
  • Hosting of the 2016 Olympics;
  • Membership of the increasingly famous and powerful ‘Bric’ nations (Brazil, Russia, India, China) and of the G20;
  • Presidential election in October 2010;
  • Future growth expectation, eg nominal GDP estimated to increase by over 800% over the next 40 years (compared to between 60% and 100% for a number of European countries);
  • An influx of foreign nationals moving to Brazil which is creating waiting lists for the international schools;
  • Conference organiser ICBI now run a Fund Forum focused upon Latin America, which includes a day dedicated just to Brazil.
Positive forces
So why has Brazil suddenly appeared in mainstream international thinking? In fact there is nothing sudden about it. There have been a number of positive forces working in favour of this country such as:
  • Gradual and sustained improvement in economic, political and social stability following the Latin American debt default issues around the turn of the century, the hyperinflation seen in the early 1990s and the general backdrop of 30 to 40 years of one financial crisis after another;
  • Brazil gained investment grade status in 2008;
  • Government policies that encourage foreign direct investment and the development of relationships with future strategically important nations such as China;
  • Worldwide increase in demand for commodities in which Brazil has significant reserves;
  • A growing middle class which drives increased domestic consumption;
  • International investors reducing their ‘home bias’ investment tendencies in search of returns from emerging markets such as Brazil;
  • Increased choice of investment opportunity following a number of domestic IPOs, with more expected, for example Petrobras later this year;
  • The now famous Goldman Sachs report of 2003 first coined the term Bric, which captured people’s imaginations and promoted Brazil into the same conversation as the other three powerful nations;
  • A demographic which shows an increase of young people coming into the workforce with, in relative terms, a limited elderly dependent population;
  • The regulator CVM has taken action over the past ten years to clarify and standardise rules, strengthen investor protection and ensure greater information disclosure surrounding the asset management industry.
Those investors that were early to spot the positive trends have already benefited handsomely. A Brazilian investor who invested R$1,000 in the Bovespa index at the start of 2000 will now have R$4,054 (a return of 305%). For an investment of €1,000, over the same period, it would have grown to €3,020 (a return of 202%). These figures compare to the MSCI World Index which decreased in US$ terms of minus 17% during the same period.

Of course, during this period there has been plenty of market volatility and given Brazil’s emerging market status, this can be expected to continue. Interestingly, this volatility has actually helped to speed up the sophistication of the local fund management entities since they have had to be adaptable to changing conditions such as surging inflation and large currency swings. The adaptability has shown through in the creation of a range of instruments suited to such conditions along with growth in the local hedge fund industry, complementing the traditional long-only sector. When markets are volatile, it pays to have skills which profit from market downs as well as ups. The local industry
AuM have grown by around 400% between 2000 and 2010. This compares, for example, to AuM growth in Luxembourg of 110% over the same period. Both jurisdictions will clearly be happy with such progress, but far more has been written about Luxembourg than about the local Brazilian asset management industry during that ten-year period.

Today, there are around 9,000 local funds, although approximately 6,000 of these are for single institutional or wealthy private client investors due to the greater tax incentives of funds when compared to segregated accounts. Therefore, the true number of local funds which have multiple investors is around 3,000.

This tremendous growth in AuM in Brazil, albeit from a low base, is for several reasons. The improvement in the domestic economic, social and political climates allows investors to have greater confidence in risking investment beyond just cash and at the same time interest rates have generally been decreasing. Mind you, interest rates are still around a nominal 10%, equating to a real return after inflation of around 6%, so cash remains an attractive asset class. Beyond this, there has also been steady growth in pension investment and given that the nation’s population is expected to grow to 200m people, pensions will be a key source of future investment cashflow.

Finally, the underlying growth in the stock market has been a significant contributor to the AuM figures that are seen today. As this growth continues it is anticipated that there will be a slow but steady movement into equities from both cash and fixed income asset classes.

This growth has been dominated by asset management companies owned by local banks. In fact the top five asset managers have over a 60% market share of the local market. These same banks are the major players in distribution, at least of funds. Therefore, the likes of ITAU and Bradesco are very active in asset gathering and asset management. This dominance can be attributed to several factors. The industry is still relatively new and the local investors, both retail and institutional, are also in the early stages of building their investment experience. Therefore they have tended to work with the entities that they know and trust. Launching local funds is a straightforward process and Brazilian investors have tended to focus upon their local investment opportunities, ie a strong home bias. This was not only due to the attractive returns achieved in their home market but up until 2006 there was no choice for local mutual funds and pension funds since they were not allowed to invest abroad.

Since that time there has been a gradual loosening of these rules and these funds can now invest certain percentages of their assets outside of the country. However, the exposure to overseas investment is still extremely small – 2% by some estimates – and therefore Brazilian investors have some way to go yet before they have introduced appropriate levels of diversification into
their portfolios. Foreign firms within the local industry
There has been some progress made by foreign funds managers in penetrating the local industry. Some statistics suggest that around 10% of the approximately 350 local fund management entities are from outside of Brazil. Some examples are:
  • BNY Mellon acquired ARX Capital in 2007;
  • South Korea’s Mirae Asset Management moved in Brazil in 2008;
  • Banco Santander Brazil is one of the largest banks in Brazil and its asset management/insurance division represents 8% of the bank’s Brazilian profits. They manage around real 98bn in the asset management business;
  • Credit Suisse has been active in Brazil since the 1990s and has completed acquisitions of Banca Garantia and Hedging Griffo;
  • BNP Paribas Asset Management has had a subsidiary in San Paulo for over ten years providing local money management capability and today it manages around R$23bn.
There is a suggestion that these foreign firms manage around 20% of the domestic AuM. This gradual influx of non-Brazilian fund managers is important in stimulating competition in the local, bank-dominated market which in turn delivers stronger propositions to the underlying investors. Of course, establishing a new venture with no local heritage or supporting business, such as an established retail bank chain, is difficult. Therefore it is quite possible to imagine that foreign asset managers will continue to view acquisition and joint ventures as an attractive market entry strategy.

On a less positive side, broad adoption and importation of European Ucits funds remains significantly hindered by the fact that foreign funds are not permitted to be distributed to Brazilian investors through public offerings. Rather they can only be distributed by way of private placement to institutional or qualified investors through distributing entities approved by the Brazilian regulator. Therefore for the mass retail market, the foreign Brazilian fund management companies tend to distribute local Brazilian funds.

Presumably Brazil will eventually open up to the distribution of foreign funds. It is an interesting scenario to consider whether by this time European Ucits will be the only global choice or whether Asia will have finally launched an equivalent standard. With the developing links between Brazil and Asia, it should not be taken for granted that the European Ucits would be the automatic standard of choice. Stretching the horizon
So are there any signs of domestic Brazilian fund managers showing their ambition to operate on a wider scale? The answer is yes. BTG Pactual Asset Management is on record as saying that it is launching a Ucits fund which invests in the Brazilian market. This is a classic strategic position whereby BTG Pactual will claim that by being local to the Brazilian market they are better placed than global asset managers who do not have a long Brazilian heritage. Another example of this is Itaú, one of Brazil’s biggest banks, which is expanding in Japan to tap institutional investor demand, after capturing more than half of the record $22bn (€16.4bn) of investment trust flows from the Asian country’s retail investors into Brazil. Itaú has set up an asset management company in Tokyo offering Japanese institutional investors investment advice and access to offshore funds. In addition, Itaú has a Brazilian fund domiciled within a Luxembourg Sicav. A final example is Bradesco, which has launched a Luxembourg-domiciled Brazilian fund.

Therefore the typical business development approach of establishing a good position in a home market and exporting that expertise to foreign markets is clearly visible. Of course, this is not isolated to Brazil. Indeed, there is clear evidence that asset management companies from Asia-Pacific countries such as China, India and South Korea are establishing a presence in various global markets. At this stage this probably leaves Brazil trailing behind Asia in terms of international expansion. Challenges ahead
One could be forgiven for thinking that it is all good news surrounding Brazil; however, there could be challenges ahead. The economy is developing well, though finance ministers around the world will attest to how difficult it is to keep such growth within an acceptable range – not too high and not too low. There is a long way to go in terms of embedding social stability, increasing education standards and addressing disparity of wealth generation. All of these depend on continued economic growth and sensible government policies. These government policies will come under significant scrutiny in the months ahead with the passing of power from the uniquely popular Lula de Silva.

Assuming this growth in economic strength continues, Brazil will become an increasing international force. This will pose the question of what role will Brazil play in the future world order and how it will cope with increasing global responsibility.

On an industry level, the reality is that the asset management business is still young and dominated by the local banks. Open architecture has yet to take hold, thus limiting choice to investors. There has been interest from foreign asset management firms but most of the interest to date has been from the perspective of Brazil as an investment class rather than a location from which to do business. This is evidenced by the fact that according to the Morningstar Europe Database there are over 25 Brazilian single-country funds and around 80 Latin America funds based in various European domiciles.

Therefore the Brazilian authorities still have some way to go to promote the country as a place in which to build a local asset management capability. History suggests this will be difficult, however there would seem to be sufficient momentum to support the view that, indeed, the Brazilian asset management industry is finally coming of age. Martyn Cuff is a managing director at Allianz Global Investors Europe ©2010 funds europe

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