Arminio Fraga: The Intellect Behind Brazil’s Gávea Investimentos

Arminio Fraga has grown Gávea into Brazil’s largest independent money manager.


Arminio Fraga Neto awakens at his home in the hip Leblon beach area of Rio de Janeiro by 6:00 every weekday morning to go surfing — on the Web, that is. Fraga spends the first couple of hours of each day poring through online newspapers, academic papers and market research, as well as answering e-mails from portfolio managers and traders. The 52-year-old Fraga got into the habit of rising early when he lived in Short Hills, New Jersey, in the 1990s and was determined to beat the morning traffic into New York City. At the time, he was a managing director at Soros Fund Management, in charge of the fabled hedge fund firm’s emerging-markets portfolio. Today he is chairman and CIO of Gávea Investimentos, Brazil’s biggest independent investment company, with $5.1 billion in assets under management, including $1.8 billion in hedge funds.

“Every day there’s this massive amount of information from all kinds of sources: news, research, reports,” says Fraga, who is at his desk in Gávea’s modest Leblon offices by 9:00 a.m. and generally doesn’t leave before 8:00 p.m. to drive home for dinner with his wife, Lucyna, and his son, Sylvio. “I go through it all day long, connected. At the end of the day, I barely have the strength to disconnect and fall asleep.”

Few hedge fund managers are better qualified to process massive amounts of information than Fraga, who has taught economics at top universities in Brazil and the U.S. His unique curriculum vitae — he is a former governor of the Banco Central do Brasil and a distinguished scholar with hands-on experience in capital markets and an extensive career on Wall Street — has helped Fraga raise assets for Gávea since he co-founded the firm in 2003 with Luiz Fraga, his cousin, and former central bank colleague Luiz Fernando Figueiredo. Of course, it doesn’t hurt that investment returns have been good: The flagship Gávea Fund had an annualized return of 11.6 percent through July, with annualized volatility of just 8 percent, an impressive performance for a manager making macroeconomic bets on emerging markets.

Bearded, balding and a bit paunchy, the soft-spoken Fraga may seem an unlikely hedge fund honcho. But he is one of the most powerful people in Brazil, described by some as the Alan Greenspan of Latin America. Fraga headed the central bank from 1999 to 2002, a critical time for Brazil, when decisions were made that transformed the country into today’s darling among the emerging markets. Shortly before then-president Fernando Henrique Cardoso chose Fraga for the position, Brazil opted to end its longtime crawling-peg exchange rate regime, which loosely fixed the real to the U.S. dollar and other currencies of major trading partners, and introduced a new way to anchor the currency: inflation targeting. Fraga reinforced the new inflation policy and insisted that the government maintain a tight fiscal stance. At vital moments he raised interest rates aggressively to protect against a run on the real.

“Fraga was part of a dream team — including the finance minister Pedro Malan — that created the economic framework for the country’s current success,” says Jacob Frenkel, vice chairman of insurer American International Group, who was governor of the Bank of Israel for part of the time that Fraga led the Brazilian central bank. “They ridded the country of the virus of hyperinflation, which had been so much a part of its DNA in the past.”

Adds Jerome Booth, head of research at London-based Ashmore Investment Management, which manages about $25 billion in emerging-markets funds: “Fraga is a superstar. He put up interest rates aggressively when it was necessary and then rapidly brought them down again. He is a genius, and everyone knows that.”


The orthodox macroeconomic strategy put in place by Cardoso, Fraga and Malan formed the basis for Brazil’s current economic stability. Brazil’s neighbor Argentina adopted a much more heterodox, populist economic policy and is now dealing with the consequences. Brazil is set for an economic rebound in the third quarter of this year, whereas Argentina has stagflation, capital flight and shaky government finances.

Fraga has brought the same fiscal prudence and conservative management style to Gávea, which is headquartered in Rio de Janeiro and also has an office in São Paulo. The firm — one of the first independent hedge fund managers in Brazil to invest in all emerging markets — employs a research-intensive investment process that combines top-down macro and political research with bottom-up equity research and quantitative analysis.

Unlike his former boss George Soros, who famously favors big bets, Fraga prefers to place small wagers and make directional plays only when they are backed by a high level of conviction. Gávea’s hedge funds typically have time horizons of months, not days, and have never borrowed money to invest. (Brazil does not allow hedge funds to take on debt to finance positions.) The firm does, however, use derivatives to obtain leverage.

Since 2006, Gávea has expanded into private equity and wealth management, two areas that have grown, respectively, to $2.6 billion and $700 million in assets. Its first private equity fund — which raised $222 million at its inception in July 2006 and is now closed — has already returned 78 percent of its capital and is expected to have an annualized net return of more than 35 percent, based on the recent fair market value of its private equity investments, when it is due to finish unwinding by the first half of 2011.

Fraga says one of the things he enjoyed most about his tenure at Soros was that firm’s civilized, friendly culture, which he has attempted to duplicate at Gávea. The open plan of the offices is meant to encourage teamwork. Fraga himself is affable and gracious, although he tends to fidget in his seat, which is located near those of Gávea’s economists and traders. He says he tries to avoid second-guessing colleagues, as he wants to foster lively, open debate and ensure that people are not afraid to take risks. Fraga notes that there is enough action in the markets without the distraction of office politics. High-quality research underlies all the decisions made at Gávea, giving it the feel of a university economics department or a public policy think tank.

Today, Arminio and Luiz Fraga own 70 percent of the firm’s equity between them; 19 other partners own the rest. Of the shop’s staff of about 100, 14 are senior managers and 32 are investment professionals. Arminio says Gávea is lucky to have Amaury Bier, a former deputy finance minister of Brazil, as CEO to handle the day-to-day administration of the firm, enabling him and his cousin to concentrate on managing the funds. Arminio, who spends the vast majority of his time on the hedge fund business, is head of Gávea’s three investment committees. Luiz, the former president of Latinvest Asset Management do Brasil, oversees private equity investments (which Gávea calls its “illiquid strategies”). Marcelo Stallone, who joined the firm as a partner in April 2003 from Dynamo Administração de Recursos, an $800 million Rio de Janiero–based money manager, heads up its wealth management business.

With an American mother and a Ph.D. in economics from Princeton University, Fraga is one of the most Western-minded business leaders in Brazil, and one of the best connected. He is a member of the Group of 30, a low-profile but highly influential Washington-based think tank whose members include National Economic Council director Lawrence Summers, European Central Bank president Jean-Claude Trichet and former Federal Reserve Board chairman Paul Volcker. Fraga was an important contributor to one of the group’s recent reports — Financial Reform: A Framework for Financial Stability — which provided the intellectual underpinnings for much of the Group of 20 finance ministers’ thinking on international financial markets reform. In April, Fraga assumed another important position: the nonexecutive chairmanship of BM&F Bovespa, Brazil’s principal stock market and commodities and futures exchange.

Brazil is an extraordinarily diverse country geographically,with astonishing natural resources and a population of 191 million. However, until a few years ago, Brazilians could never take their country seriously: It might be fun, but it would always be broke. A conversation about politics with Brazilian economists would usually end with their concluding ironically, “Brazil is the country of the future, and it always will be.” It was for good reason that they thought that way: Until the most recent currency, the real, was introduced in 1994, Brazil was plagued by hyperinflation, and even as recently as 2002, public debt amounted to more than 50 percent of GDP (last year the debt-to-GDP ratio was down to 40.7 percent).

Today, Brazilians take deep pride in how far their country has come during the past decade. They look down on their Argentinean neighbor, which traditionally had been seen as the more sophisticated of the two but whose economy now seems stuck in a time warp. Currently, inflation in Brazil is running at 4.4 percent a year; economists estimate that the rate in Argentina is about 15 percent. From 2004 through last year, Brazil’s average annual GDP growth was 4.45 percent. Last year it received more direct foreign investment than any other nation in Latin America: a total of $45 billion, 30 percent higher than its then-record 2007 figure.

Brazil’s recent success can be partly attributed to luck. In 2001, while Fraga was at the central bank, the country was included in a report by Jim O’Neill, a Goldman, Sachs & Co. global economist, on the most promising emerging markets of the future. It was O’Neill who coined the acronym BRIC (Brazil, Russia, India and China), which has become convenient shorthand for the most important emerging markets. Brazil’s inclusion in the group has no doubt increased the country’s appeal to investors. According to the International Monetary Fund, Brazil’s total GDP was $1.57 trillion last year (making it the tenth-largest economy in the world), compared with China’s $4.4 trillion, Russia’s $1.67 trillion and India’s $1.2 trillion.

Brazil’s hedge fund industry has not developed nearly as rapidly as the country’s overall economy. Brazilians often refer to a large funds category called multimercados as hedge funds, but that is misleading because many of the funds in that group are capital-protected or invest only in bonds. Just a few subsectors of the multimercados industry — such as long-short equity and multistrategy funds that invest in equities and use leverage — are true hedge funds. Multimercados have total assets of $160.5 billion, but analysts say that the 50 or so true hedge funds manage only $16.2 billion.

ARMINIO FRAGA GREW UP IN AN UPPER-MIDDLE-CLASS home in Rio de Janeiro. His father, Sylvio, was one of the city’s leading dermatologists. Sylvio met Fraga’s future mother, Margaret, while doing his residency at Temple University in Philadelphia. In Rio, Fraga’s parents sent him to a Jesuit school, Colégio Santo Inácio, not out of any religious conviction but because it is one of the city’s best schools.

“I was in the top 10 to 20 percent — not very scholarly,” recalls Fraga. “I liked math and the sciences.” Until the age of 15, Fraga played soccer every day. Then he took up golf and began playing that every day, becoming good enough to represent Brazil on the under-18 national team during his last year at Santo Inácio. He still plays golf, although not, he says, nearly as well as he used to.

Following his secondary education, Fraga studied economics at the prestigious Pontifícia Universidade Católica do Rio de Janeiro and went on to earn his Ph.D. at Princeton. For his thesis he wrote about international loans and economic adjustment.

In 1985 he went back to Brazil to work as chief economist for Banco Garantia, a major local investment bank. There he learned how to do proprietary trading in Brazilian markets.

Fraga left in June 1988 to take a post as an assistant visiting professor at the University of Pennsylvania’s Wharton School. At the same time he was a research associate for the Cambridge, Massachusetts–based National Bureau of Economic Research, before moving back into investment banking in July 1989. For two years he was a vice president at Salomon Brothers in New York, where he did proprietary trading in emerging markets. In 1991 he returned to Brazil to work as international director at the central bank. He was made a deputy governor at the age of 33, one of the youngest ever in Brazil. Cardoso was a national senator at the time, and they had friends in common, including Pedro Malan, who had taught Fraga economics at PUC. Fraga would have occasional discussions with both men about economic policy, even after Cardoso became president in 1995.

“I used to have some phone calls with Arminio just to know myself what was going on around the world,” recalls Cardoso, who wanted to bring Fraga back into the government as early as 1993, when he was finance minister. “He was a well-informed person and goes straight to the point. I valued that.”

By then, Fraga had returned to Wall Street to work for Soros. He was made a partner and put in charge of the emerging-markets area, which was under the overall portfolio management of then-CIO Stanley Druckenmiller.

“I’m happy to report that during my six years at Soros, Stan never second-guessed me once,” says Fraga. “I think that is a remarkable trait, and you bet I behave like that when dealing with colleagues at Gávea today.”

Economics is one of Fraga’s great passions. While at Wharton he taught a class on the capital markets of developing countries and an international finance class. During his time at Soros, he gave classes at Columbia University’s School of International and Public Affairs on capital flows, investments and economic policy in emerging markets. He has also taught economics at Brazil’s best universities, including Rio’s Fundação Getulio Vargas and his alma mater, PUC.

In January 1999, Fraga received a call at home in New Jersey from Cardoso offering him the governorship of the central bank. Based on previous conversations with Cardoso, Fraga had thought he might be tapped for the position of governor one day but was surprised by the timing. He also knew that the decision to airlift him from a hedge fund to the central bank could be controversial.

Was it ever. On February 11 economist Paul Krugman suggested in a column he wrote for online magazine Slate that in the days before the announcement of the new central bank governor’s appointment, George Soros had been trading on inside information he had received from Fraga. He accused Soros of buying up Brazilian debt, which was selling at a deep discount as “the real dropped to nearly half of its original value” on rumors that Brazil was going to default and close its banks. After news of Fraga’s appointment became public, the real recovered, “partly because Soros was now able to squeeze those who had sold Brazilian debt short,” Krugman wrote.

Fraga refuted the charges. “Paul Krugman is a great economist, perhaps the best in his generation,” Fraga wrote to Slate. “As a journalist, however, he was careless, and I happened to be his unlucky victim.”

Krugman quickly recanted, admitting that he didn’t have any direct knowledge of what had happened and apologizing for what he said was “a serious error in judgment.”

Fraga’s confirmation hearings before the Brazilian Senate that March were equally contentious. Luiz Inacio Lula da Silva, then a senator representing the leftist Workers’ Party, said that nominating Fraga to be central bank governor was “like naming a drug trafficker to head the federal police.” Fraga didn’t take the bait — “Everyone has a right to an opinion,” he said — and was easily confirmed.

“It was clear for everyone that despite the fact that Arminio had worked for Soros — maybe because of it — he was even more prepared to deal with this situation,” Cardoso says.

He was immediately put to the test, as the real had collapsed after the Cardoso government eliminated its peg to the dollar a few weeks before Fraga’s appointment. The new governor acted decisively: He pushed the overnight lending rate up by 6 percentage points, to almost 45 percent, and announced that the central bank would do whatever it took to keep a lid on inflation. The currency soon recovered, and Fraga was able to cut rates again.

He appointed Luiz Fernando Figueiredo, then a partner at the local Banco BBA, to the central bank’s board in March 1999 as deputy governor in charge of monetary policy, a post he held until March 2003.

“Fraga and I always got on well,” says Figueiredo. “Sometimes we discussed our dream of setting up a fund management company one day. But we were not sure if one of us would do it first or whether we would do it together.”

In 2001 inflation hawks complained that Fraga was being too lenient, letting prices rise by 7.7 percent and missing the 4 percent target set by the central bank. Yet most analysts agree that Fraga performed well during a dreadfully difficult year and helped prevent Brazil from falling into recession. Argentina was in the midst of a meltdown, and many economists feared that Brazil would be next. At the start of 2002, Fraga even went to Buenos Aires to help his Argentinean counterparts navigate the economic storm their country was facing.

“Fraga was very generous with his time and experience,” says Mario Blejer, governor of the Argentinean central bank at the time. “He is a very decent, gentle person, and he has been one of the central figures in contributing to Brazil’s economic success.”

In October 2002, Fraga again showed resolve as the economic uncertainty surrounding Lula da Silva’s probable presidential victory battered the real. On October 14 the central bank raised interest rates by 3 percentage points, to 21 percent, the first increase in 15 months. The move calmed the markets.

It was no great surprise to Fraga, who was closely associated with the right-wing Cardoso administration, that Lula da Silva did not renew his term at the bank after sweeping into office. Fraga remembered the dream that he and Figueiredo shared of setting up a fund manager, and together with Luiz Fraga, they founded Gávea in 2003.

Figueiredo was the second-most-important partner in Gávea until October 2004. Fraga at that time wanted to grow the Rio office, but Figueiredo and his family lived in São Paulo, and he was not keen on moving to the coast. The two men parted company on amicable terms, and in 2005, Figueiredo set up his own hedge fund firm, Mauá Investimentos, which today has $300 million in assets under management.

ARMINIO FRAGA LIVES JUST a quar ter mile from Gávea’s office in Leblon, an upscale residential area of Rio that has attracted some companies, especially fund managers, during the past decade. Fraga could walk to work, but he chooses to drive (he is a famous man in Brazil, and Rio is not the safest of cities). Once at the office, he visits the trading desk for the morning call with other traders and portfolio managers. Fraga likes to keep his mornings mostly free of scheduled meetings, and he spends the time reading or brainstorming with colleagues. New investment ideas pop up frequently and are discussed informally.

“When an idea gets ready, we pull the trigger,” says Fraga. “‘We’ means the most-senior three to five partners. ‘Ready’ means enough conviction is reached.”

Fraga set up Gávea at an opportune moment, and it has performed well on the back of Brazil’s economic success. His initial vehicle, the Gávea Fund, began with $205 million, which came mostly from people Fraga and his co-founders knew.

At first he was in charge of pretty much all investments, but as Gávea’s traders and economists have built up experience, he has delegated more of the decision making. In the process, Gávea’s investment team has amassed a lot of frequent-flier miles. Gabriel Srour, a senior portfolio manager and trader, and Edward Amadeo, Gávea’s chief economist, travel — often together — to Latin America, Asia and Eastern Europe several times a year.

During its first year, Gávea restricted its investments to roughly a dozen emerging markets. Today it is capable of playing in 20 countries. “Even now we like to concentrate bets, but now we can follow up a lot more stories at the same time,” notes Srour. “That’s the main difference from before.”

By January 2005 the flagship Gávea Fund had grown to $500 million, and Fraga launched the Gávea Brasil Fund to invest exclusively in Brazil. He also began to turn bearish, gradually moving away from equities to make macro bets on interest rates, currencies and fixed-income securities. As a result, Gávea missed the huge rally in emerging-markets stocks that started in August 2007 (the Gávea Fund was up 10 percent that year), but it also missed the crash.

“In 2005 we started to see — perhaps way too early for our own good — that there were some global issues that could end in tears,” recalls Fraga. “As a result, for the last three years, we have been more macro- than stocks-driven.”

Fraga has a clear macro bias and likes to trade on monetary policy. At the start of this year, he decided to make a directional play on the Hungarian currency and bond markets. Gávea bet that Hungary’s central bank would maintain high interest rates and that its currency, the forint, would depreciate because of problems in Eastern European economies (both have happened).

One of Fraga’s best bets during the past year actually had little to do with emerging markets. Last fall, Gávea began buying U.S. Treasury Inflation-Protected Securities. Its investment team recognized that, after Lehman Brothers Holdings filed for bankruptcy in September 2008, the markets were factoring in the possibility of deflation, which sent the price of TIPS tumbling. For Gávea buying the bonds was a no-brainer, as the U.S. Treasury limits the amount of principal that can be lost on them in case of deflation. Gávea’s bet would have come unstuck only if the U.S. government did not honor its guarantee, and Fraga thought that unlikely. In addition, the break-even inflation rate implicit in TIPS pointed to 2 percent deflation over eight years, which Gávea believed was a huge distortion. In fact, the firm believed that inflation expectations would move higher — which they did.

Like many hedge fund managers, Fraga has had to deal with investor angst during the past year. His firm’s flagship fund, which was down just 5.97 percent last year, has seen its assets shrink from nearly $1.3 billion in July 2008 to about $800 million today, as clients have turned skittish on the heels of events in global financial markets and redeemed.

“Even though we didn’t crash, we did have redemptions,” allows Fraga. “We still manage plenty of money, but we had significant redemptions from a few large investors. They themselves suffered redemptions, so they had to withdraw funds. Our hedge funds are completely clean; they require only 90 days’ notice.”

Investors who stuck with Gávea are probably happy. The Gávea Fund was up about 13 percent this year through July, despite the fact that its portfolio has been extremely lightly invested, with about 60 to 70 percent of its capital in cash.

Fraga, for his part, remains convinced that Gávea is pursuing the right strategy — even if that means missing some of the market highs. He is cautiously optimistic that the firm’s hedge funds will attract more investors this year, especially given that interest rates in Brazil have fallen below the psychologically important 10 percent barrier for the first time and investors’ appetite for certificates of deposit should diminish.

“My view of what’s happening in the world is still one of less enthusiasm than what I see out there,” Fraga explains. “I think it’s a bit too much. The response [by governments and regulators] was massive — it had to be done, but there will be costs. The aftermath won’t be so good. I don’t think we’ll go back to the kind of growth that we saw during the bubble years, and I’m not so sure what people are thinking.”

There’s little doubt, however, about what Fraga is thinking. He seems genuinely happy managing a hedge fund. He says he may return to government when he is 60. He loves academia, as he likes to keep up-to-date with economics research and enjoys the intellectual discipline it demands. Fraga may take on another teaching post shortly. But in many ways, at Gávea he has created the next best thing to a university economics faculty: a highly research-driven fund management company with a strong macro bias.