| NEW YORK, April 4
NEW YORK, April 4 Brazil's decision to hike its
key interest rate to 11 percent, its highest level in two years,
has some yield-hungry U.S. investors smacking their lips.
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 digit yields.
"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
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 United States.
"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 since then.
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 yields.
"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)