Midnight in Rio isn’t supposed to be like this. That’s where Marcelo Mesquita runs UBS’s eight-person Brazilian equity research department; he’s also its chief strategist, and last year he took on an additional role: petrochemicals analyst. Although six interns assist the 34-year-old analyst and sophisticated technology allows him to stay in touch with fellow researchers and keep tabs on markets around the world, Brazil’s recent bull market has been keeping Mesquita at work later and later. “There’s more to do, so we spend more hours in the office,” he says.
Two hundred and twenty miles away in São Paulo, Unibanco research chief Sergio Goldman concurs. “The work hours are quite long, and there’s pressure to come up with ideas.”
All this hard work is good news in Brazil. Local markets rebounded from a three-year bear market with a vengeance last year. The benchmark Bolsa de Valores de São Paulo, or Bovespa, index was buoyed by lower interest rates and renewed economic growth under the surprisingly market-friendly government of President Luiz Inácio Lula da Silva and doubled to 22,236 in 2003, making Brazil second only to Thailand among all the world’s markets. Average daily volume on the bourse was up by almost the same rate, to $374 million in July, compared with a year earlier. The Bovespa had added a further 4 percent this year through mid-August.
Bonds have performed nearly as spectacularly: Last year the J.P. Morgan emerging-markets bond index plus Brazil, which tracks the country’s external debt, returned 68.1 percent, while the certificado de depósito interbancário index of domestic floating-rate debt returned 23.2 percent. Although external fixed-income markets lost 0.77 percent in 2004 through mid-August, local bonds jumped by 9.5 percent.
The surging markets have refilled the coffers of Brazil’s major institutional investors, pensions and mutual funds. In all, they oversee more than $200 billion today, $80 billion more than they did in December 2002.
This burst of prosperity has helped solidify Brazil’s role as Latin America’s top capital market, boasting the continent’s largest economy, biggest bond market and oldest equity bourse. The 359 companies listed on the Bovespa, which dates back to 1890, had combined total market capitalization of $230.5 billion as of mid-August.
“Brazil has strong, well-run companies with attractive valuations,” says Brad Aham, Boston-based head of emerging markets at State Street Global Advisors’ global active equity group, which devotes about 9.5 percent of its $3 billion emerging-markets portfolio to Brazil. “There’s volatility there, but not enough to scare investors away.”
Recognizing this enormous investment potential and the top-notch analytical skills needed to exploit it, Institutional Investor this month presents for the first time the All-Brazil Research Team, our exclusive ranking of the country’s best analysts.
São Paulo-based Credit Suisse First Boston is the winner of our inaugural All-Brazil Research Team, with a total of eight team positions. UBS, with a total of seven slots, comes in second, followed by Itaú Corretora de Valores, with six, and Banco Pactual with four. The rankings are based on the opinions of representatives from more than 100 institutions who oversee $29.3 billion in Brazilian equities -- or about half of the Bovespa’s free float -- and more than $55 billion in Brazilian debt.
For the past 12 years, we have highlighted Brazilian research in our Latin America Research Team but only as a discrete country category or as a component in regional industry and macroeconomic research. This new team breaks out Brazilian research on its own. We present seven industry sectors, including Banking & Financial Services, Capital Goods/Diversified Industrials, Chemicals & Oil, Consumer Goods, Electric & Other Utilities, Natural Resources, Telecommunications Services; two macro categories, Economics and Equity Strategy; and Fixed Income.
The leading firms are all savvy survivors of markets that have at times been treacherous for investors and analysts alike. In the mid-1990s many foreign investment banks and brokerages set up shop, hoping to take advantage of a large, growing economy and a stable currency that had gradually overcome the shocks of the 1980s Latin American debt crisis.
But the good times didn’t last. Spooked by the Russian ruble crisis in August 1998, investors began to view the real and other Latin currencies as overvalued. The regional crisis forced the Banco Central do Brasil to decouple the real from the dollar in January 1999; the currency fell from R1.32 that January to R3.53 at year-end 2002. Brazilian stocks, swept up in concerns about neighboring Argentina’s slow-motion collapse over the course of 2001, fell nearly 54 percent from their late-January 2000 peak through mid-October 2002 as trading volume slowed to a trickle. Net foreign investment in Bovespa stocks went from R2.23 billion ($1.85 billion) in 1999 to outflows of the same amount in 2000, rebounding to R816 million in 2001; R1.4 billion flowed out in 2002. The market capitalization of the Bovespa remained roughly flat in local currency terms before rising in 2003, but the number of companies trading on the exchange dropped from 478 in 1999 to 369 in 2003.
Numerous foreign brokerages pared their local operations or left, including Dutch bank ABN Amro and ING Groep (ABN Amro has since returned and is looking to expand). “The trend was to shrink or shut down equity research departments, transferring analysts to New York or London,” says São Paulo-based Manoel Rebello, senior partner and leader of the financial services practice for Southern Europe and Latin America at executive search firm Heidrick & Struggles. “You could count on your two hands the number of firms that had real research departments” in Rio or São Paulo, he says.
Even among those that stayed, many firms laid off equity researchers and cut their coverage lists. Some shut their Brazilian research operations entirely. “A lot of local analysts have left the sell side because, in the past three to four years, business hasn’t been so good,” Unibanco’s Goldman says.
The withdrawal of prominent foreign asset managers further cut the demand for research. Italy’s Banca Nazionale del Lavoro, Bank of America, Germany’s Dresdner Bank, Lloyds TSB Bank of London and J.P. Morgan Chase & Co. all sold off part or all of their local money management divisions. By one estimate, the number of Brazilian asset managers fell by nearly one third -- from 157 to 109 -- between 1997 and 2003.
Much has since changed. Firms aren’t exactly throwing reais at research these days, but they can’t afford to ignore the remarkable opportunities that Brazil offers. Slowly, firms are beginning to add analysts and open new coverage areas to bolster one of the local market’s traditional strengths: topflight equity and bond research that has been practiced for more than three decades locally.
A resurgent local buy side is helping drive the measured expansion. This May, according to the Secretaria de Previdência Complementar, Brazil’s social security department, local pension funds reported $69.6 billion in assets under management, up from just $47.3 billion in December 2002. And mutual funds are sprouting up everywhere: Brazil now has 4,822 mutual funds with a combined $175.9 billion in assets under management, compared with 4,424 funds with $97.3 billion in assets in December 2002, according to Associação Nacional dos Bancos de Investimento, the mutual funds association. Brazil is a major contributor to the $7.95 billion in total hedge fund assets that now reside in Latin America, according to New York-based research firm Hennessee Group’s 2004 managers survey. (Individual country totals were not available.)
These and other types of investors included in our poll say they’ve noticed an improvement in research during the past year. In a survey conducted by II in conjunction with balloting, 37.3 percent of respondents said local research had improved in the past 12 months; 46.6 percent said it had stayed the same; just 16.1 percent said it had deteriorated.
One measure of Brazilian research’s status: CSFB fixed-income analyst and economist Rodrigo Azevedo, who places first in Fixed Income and third in Economics, joined the Banco Central do Brasil in late July in the important job of director of monetary affairs.
Still, the hangover effect from the past three years hasn’t completely lifted. Analyst salaries, which in the mid-1990s approached the lower end of U.S. researcher salaries, dropped drastically in U.S. dollar terms and remain low. “Today you can hire a good analyst for $50,000 plus a bonus of about six months’ salary,” says Nami Naneas, head of institutional sales at Banco Banif Primus, the local arm of Portugal’s Banco Internacional do Funchal, in São Paulo.
The contraction in business prompted firms to run relatively lean local departments. Santander Investment Securities has eight senior analysts; UBS has six senior (and two junior) analysts; Unibanco has five; and ABN Amro, Banco Brascan and Banif Primus have four apiece. Altogether, more than 230 analysts employed by 46 brokerage houses received votes in our survey for their Brazil coverage.
Analysts in Brazil typically follow two or three related sectors, since there are too few Brazilian companies large and liquid enough in each sector to allocate one sector per analyst (the notable exception is the telecommunications area). Wherever possible, Brazilian research directors say they try to ease the burden on analysts by assigning them complementary sectors such as oil, electricity, petrochemicals and utilities.
Although they need to keep track of more industries, the researchers follow far fewer companies in each sector than their counterparts, say, in the U.S. As a result, some leading analysts rank in more than one category: Paolo Di Sora of Itaú Corretora, for example, is the first-teamer in both Capital Goods/Diversified Industrials and Natural Resources, while CSFB’s Emerson Leite ranks No. 1 in Chemicals & Oil, No. 2 in Capital Goods/Diversified Industrials and No. 3 in Electric & Other Utilities.
The fact that so many sectors have few companies provides a challenge for research directors, who need to deploy their resources carefully. Unibanco, for example, restructured its department in the past year to create five teams, each with a senior and a junior analyst, who together cover ten to 12 stocks across several sectors. Previously, says research chief Goldman, some of the firm’s researchers covered as few as four or five stocks, and some analysts didn’t have assistants. Now only the telecoms analyst confines himself to one industry. The others track banks, petrochemicals and transportation; consumer sectors (beverages, food, retailing and tobacco); mining, pulp and paper, and steel; and oil and utilities. The combined efforts allow the senior analysts to interact closely with clients while junior analysts do much of the number crunching and get a chance to learn the fundamentals of the businesses they track.
The institutions that provide Brazilian research fall into two categories: local firms such as Itaú Corretora, Pactual, and Unibanco that serve a predominantly Brazilian client base; and global firms -- CSFB and UBS, among others -- that serve both Brazilian and global clients. Some firms, primarily local ones, are moving toward regional coverage, with Brazil-based analysts following Argentinean and Chilean stocks as well; UBS, among other global investment houses, is also regionalizing.
By expanding regionally, a local firm can cover more companies in each sector and reduce some of the multi-industry responsibilities analysts now have, says Itaú Corretora’s Tomás Awad, who ranks third in Banking & Financial Services. “If we did Latin America, we could each follow one sector” rather than two or three, he explains. Although still predominantly local in coverage, Itaú Corretora is gradually expanding its reach. The firm’s telecoms analyst is picking up coverage of Mexican companies, São Paulo-based Awad says, “and I should add regional banks one to two years out.” Itaú Corretora has a team of seven sector analysts.
Brokerages like Itaú Corretora, says Awad, have solidified their hold on local clients because of the ebbs and flows in foreign firms’ interest over time. “We, as a local brokerage, took advantage of the divestments from global houses. Clients may be more comfortable with us because we’ve been consistently here,” he explains.
Whether the brokerage is a local or foreign house, investors agree they like the local color. Of those responding to II’s survey, 71.4 percent said it was very important that an analyst be based in the same country as the companies he tracks. Only 5.9 percent thought it wasn’t important.
“Being part of a global house is a big advantage because of the technology we have,” says UBS’s Mesquita, who is top-ranked in Equity Strategy and the third-teamer in Chemicals & Oil. UBS’s team features six analysts in Rio with regional coverage responsibilities as well as Mexico- and Chile-based strategists and two New York-based analysts who follow Brazilian stocks. The firm’s souped-up internal systems allow analysts to access the research of its analysts around the globe, so Mesquita can compare his Petróleo Brasileiro, or Petrobrás, forecast with those made by other analysts concerning oil companies around the world. “There is a lot of demand from local investors for global information and a lot of demand from global investors for local flavor,” Mesquita says, “so we’re well positioned in the middle.”
Fifth-ranked Santander also takes a regional view but in a different way. Eight of its analysts are stationed in Brazil, but analysts are also posted in Argentina, Chile, Colombia, Mexico, Peru and Venezuela. “We cover more stocks in Latin America than any other brokerage,” says Dario Lizzano, New York-based head of equities for Latin America at Santander Investment Securities. His firm is looking to add two or three analysts to its Brazilian team “in the relatively short term,” to increase Santander’s coverage of smaller-cap stocks, Lizzano says.
Unibanco’s Goldman sees coverage expanding into regional and small-cap names but without adding to its five two-person teams, all of which are based in São Paulo.
The emergence of local hedge funds, which began to sprout in 2000, has also changed the way analysts approach their work. The hedge funds’ arrival prompted Santander’s Lizzano to bring his team of 25 regional analysts together in Cancún, Mexico, in January for a sit-down. “We need to adapt to what the client wants, and that means actionable ideas, both on the long and short sides,” he told them. “We need to focus on short-term trading opportunities. More hedge funds are coming, and they are key commission payers.”
As the profiles on these pages suggest, a number of Brazilian analysts are putting out the sorts of relative-value calls that hedge funds crave. Itaú Corretora’s Di Sora, for example, urged clients to get into raw-steel-maker Gerdau and out of finished-steel-maker Co. Siderúrgica Nacional. Gerdau’s shares subsequently leapt 51.8 percent by mid-August, while CSN’s eked out a 3.8 percent gain.
More than anything else, hedge funds want ideas, says Banif Primus’s Naneas. “Each day we are trying to get their attention, to get their orders,” he explains, by searching out arbitrage opportunities between different markets, such as local shares and their American depositary receipt counterparts, between European parent companies and their Brazilian subsidiaries and within Brazilian sectors. “We’re trying to get our own space,” he says. “We’re not trying to compete with UBS or Merrill Lynch, but sometimes we can steal clients from them.”
But there is more to be done. Rodrigo Magela, a former telecoms analyst at Banco Pactual who joined Rio de Janeiro-based fund manager ARX Capital Management in April, says that “the sell side needs to be more focused on flows, on details and on trading ideas.” Magela, whose new employer manages a total of R1.2 billion, gave up the sell side “to be closer to the action,” he says. ARX Capital runs three hedge funds with R800 million in combined assets, he says.
That Brazil still presents challenges to investors was evident this June. Foreign investors, anticipating that higher U.S. interest rates would reduce demand for Brazilian equities, pulled $189 million in capital from the Brazilian market -- the first such outflows in more than a year.
But new political leadership has given the country far more resilience to overcome these challenges. Lula, whose Socialist background initially scared investors, has adopted centrist economic policies -- cutting spending, stabilizing the real, reducing deficits and launching a much-needed pension reform program. Banco Central has lowered interest rates nine times in the last 15 months, to 16 percent, the lowest level since April 2001. Although overall GDP declined by 0.2 percent in 2003, it grew in the final part of the year and surged by 5.7 percent in the second quarter of 2004 versus the same period a year earlier.
Many analysts expect further cuts in interest rates, to 15 percent by the end of the year and to 14 percent by the end of 2005, which should make equities relatively more attractive. With Brazilian pension funds’ average allocation to equities at just 27 percent and dedicated equity mutual funds making up just 6 percent of the local fund marketplace, there’s plenty of upside left.
André Loes, director of research at Santander in São Paulo and second-teamer in Economics in our survey, predicts that in the next 12 months pension and dedicated equity mutual funds will increase their Brazilian equity investments by about 10 percent, or by roughly R7 billion. Among institutional investors, 62.5 percent of those answering the question say they plan to increase their allocations to equities this year, while only 3.6 percent indicate that they will reduce their equities holdings. Market participants say buy-siders will be attracted by a stable economy and currency and by lower rates that will reduce the relative appeal of fixed income, among other factors.
Brazil has also seen the beginning of a resurgence of the initial-public-offering market this year with the $200 million IPO of cosmetics company Natura Cosméticos on May 26, the country’s first new issue since February 2002. Two additional companies debuted publicly in June: railroad América Latina Logística, $170 million, and low-cost airline Gol Linhas Aéreas Inteligentes, $280 million. “A lot of companies are now talking about going public,” says Itaú Corretora’s Awad.
All this market growth should be good for analysts. Naneas expects a doubling of the number of sell-side research analysts in Brazil in the next five years, from an estimated 125 to 150 today. Salaries, too, should grow as commissions on the equities side begin to increase. “As the market gets bigger, with more IPOs in the pipeline and volume growth and economic growth, there will be a big demand for more analysts,” UBS’s Mesquita says.
In the interim the hard-working research director, strategist and sector analyst will continue to burn the midnight oil in Rio. -- Pam Abramowitz
Picking the team
This year, for the first time, Institutional Investor presents the All-Brazil Research Team. II has had a category for Brazil country analysis in our Latin America Research Team since that survey’s inception in 1993.
To select the members of the inaugural Brazil team, we invited directors of research and heads of investment at hundreds of institutions in Brazil and in other countries to complete a Web-based questionnaire. We also contacted key institutional clients -- both analysts and portfolio managers -- from lists submitted by brokerage firm research directors. Investors who did not respond online were contacted by phone to determine whether they would be willing to participate.
The Brazil team reflects the results of voting in ten categories, which comprise seven equity-related industry categories, one fixed-income sector and two macro disciplines. Since most brokerages cover each Brazilian industry with just one senior analyst, we highlight individual performance.
The rankings are derived from numerical scores produced by weighting each vote based on the respondent’s Brazilian equity or fixed-income assets under management and on the place the respondent awarded to the analyst (first, second, third, fourth). Each member of the Brazilian team also had to meet a minimum vote count. Voter response was sufficient to publish complete teams (first, second and third place) in eight categories; we recognize only a first-teamer in Fixed Income and first- and second-teamers in Capital Goods/Diversified Industrials.
Our reporters interviewed voters to learn more about the analysts and firms they had selected. Analysts were contacted to clarify points their clients had raised, to confirm certain stock prices or to get their assessments of the year gone by. Analysts who switched firms after July 9, 2004, are cited at their previous organizations.
Prices quoted in the category reports are in U.S. dollars unless otherwise noted. Brazilian share prices in the text are for “quotation lots"; the size of these lots varies by stock and is specified as necessary.
The results reflect the opinions of investors from more than 100 institutions, domestic and foreign, managing some $29.3 billion in Brazilian equities, or 49 percent of the Bovespa index free float, and more than $55 billion in Brazilian fixed income.
The ranking was compiled by II under the direction of Assistant Managing Editor for Research Lewis Knox and Senior Editor Jane B. Kenney with Researchers Ricardo Beninatto, Daniel Gaviria and Carolina Santos. Contributing Editor Ben Mattlin and Contributors Pam Abramowitz, Scott Martin and Vincent Morkri wrote the category reports.