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Brazil Emerges

Brazilian money managers prepare for foreign inflows.

Brazil’s money managers have more to celebrate these days than just being part of one of the world’s best–performing economies. On April 30, Standard & Poor’s up–graded the nation’s long-term foreign currency debt to investment grade. The change is of particular importance to institutional investors that are not allowed to invest in an emerging–markets country’s bonds if they are not investment grade, according to José Brazuna, general manager of the asset management division at the National Association of Investment Banks, a São Paulo–based trade organization.

“We will have a lot of foreign pension funds that will come to Brazil to invest,” agrees Ricardo Mizukawa, a product management specialist at Bradesco Asset Management in São Paulo. “That will be a big change.”

In explaining the upgrade, the New York–based credit rating agency cited the Brazilian government’s “pragmatic macro-economic policies” that had strengthened the foundation for sustained growth in real gross domestic product, and noted that the year–to–date foreign direct investment of $12.4 billion was on track to match last year’s record $34.6 billion — more than enough to -cover the nation’s estimated current–account deficit of $20 billion.

The upgrade occurred nearly a year before anyone in the country’s investment community expected it. Brazil, once the world’s biggest emerging–markets debtor, has been making steady progress since President Luiz Inácio Lula da -Silva took office in January 2003. As S&P noted, Brazil’s external debt (net of liquid external assets) has declined dramatically, from more than 100 percent of current-account receipts whenLula took office to a projected 3 percent for 2008. The NAIB’s Brazuna says the hope was that Brazil’s debt rating, which had risen as high as BB+ (one notch below investment grade), would make it to the first rung of investment grade “maybe in 2009, or maybe even by the end of this year, but -never sooner than that.”

News of the upgrade rejuvenated Brazilian markets. The benchmark Bolsa de Valores de São Paulo, or Bovespa, index soared 6.33 percent, closing at a record 67,868.46 on April 30 and erasing its slight year–to–date loss. Brazil’s stock market was in the doldrums in the first four months of 2008 as inflation, which rose to 5.04 percent for the 12 months ended April 30, prompted the Brazilian Central Bank’s Monetary Policy Committee to raise its benchmark Selic interest rate, by 50 basis points, for the first time in nearly three years. Walter Mendes, head of equity investments at Banco Itaú in São Paulo, predicts the Selic rate, currently at 11.75 percent, will jump to 14.25 percent by September. “Everybody in Brazil thinks this is just a temporary increase, to avoid inflation spreading throughout the economy,” he says. “The Federal Reserve Bank in the U.S. has been complacent about inflation, but in Brazil the central bank is not complacent at all.”

High interest rates — the Selic reached 19.75 percent in 2005 — and concerns about the long–term sustainability of the nation’s economic recovery have prompted many investors to pour money into lower–risk fixed–income instruments rather than Brazilian equities, even though the Bovespa -surged 43.6 percent last year, 32.9 percent in 2006, and 27.7 percent in 2005. But that trend has started to reverse, and money managers hope the S&P upgrade will speed the change.

At Banco do Brasil Administradora de Ativos, which holds the top spot in the Brazil 20, Institutional Investor’s inaugural ranking of the country’s biggest money management firms, the percentage of assets under management in equities has grown from 14.3 percent in 2003 to 22.8 percent as of March, according to Alberto Monteiro de --Queiroz, president of BB DTVM, the asset management arm of Rio de Janeiro–based Banco do Brasil. Queiroz believes the trend will continue. “Now that Brazil has received the investment grade, things are certainly going to be much better — not only for the equity side but also for the whole Brazilian economy,” he says.

Second-place Itaú has seen similar growth in equity investment. The firm now has about 12 percent of its assets under management in equities, up from 5 percent in 2003, says Mendes. The inflow of assets into equities “happened -mainly in the past two years, when local investors invested continuously — every month,” he adds.

Renato Prates, who develops investment products for the No. 3 firm, government–owned Caixa Econômica Federal in São Paulo, says he also noticed the shift from fixed income accelerating in the past two years; equities increased to 7.2 percent of the bank’s total assets under management last year, from 4.4 percent in 2006.

Given the interest in the Brazilian stock market and the strength of the nation’s economy, the country’s money managers have been busy launching new funds to appeal to investors at home and abroad. Last August, Itaú opened two funds in South Korea in partnership with Korea Development Bank, each of which has attracted about $150 million in assets, according to Luís Otávio de Carvalho Oliveira, Itaú’s manager of institutional investment. The funds’ structures allow investors to decide whether they want “pure equity, pure bond or a balanced mix of bonds and equity,” he says.

Last month the bank announced it would be launching similar funds for Japanese investors. “We’ve already been successful in -Korea, so we are very confident,” Mendes says.

In October the fifth–ranked firm, UBS Pactual Asset Management in Rio de Janeiro, introduced two funds for European investors: UBS (Lux) Bond Sicav – Brazil (USD) B and UBS -Equity Brazil. As of May 15 the bond fund had attracted $247.7 million in assets, with a 6.4 percent gain since inception, and the equity fund had grown to $1.02 billion, with an 18.0 percent gain since inception.

In March, the No. 8 firm, ABN Amro Asset Management, introduced the Real Capital Protegido 2 Sundo de Investimento Multi Mercado fund, which will use options to protect against downside risk. That fund, which is open only to the São Paulo–based bank’s wealthier local private clients, attracted 80 million reais ($45.9 million) during its 30–day subscription period, which ended April 1, says ABN Amro investment strategist Aquiles Mosca. “We will also create a retail version for the second half of this year,” he adds.

Brazil’s initial public offering market is also a strong draw, notes Herculano Aníbal Alves, chief investment officer for equities at fourth–ranked Bradesco. Last year about $34 billion was -raised in the Brazilian IPO market, and $2.7 billion in new equity issues was floated in the first four months of this year, with “foreign investors buying about 7 percent of these IPOs,” he says.

Two of the past year’s biggest offerings were exchange–related. In October, Bovespa Holding, then parent company of the stock exchange, went public in an IPO that raised R6.6 billion — the biggest IPO in Latin American history — and in November, Bolsa de Mercadorias & Futuros, a commodities and futures exchange, raised R6.0 billion in its initial float. The two -merged last month to become BM&F Bovespa, the world’s third–biggest securities exchange in terms of market value, after Frankfurt–based Deutsche Börse and futures giant CME Group in Chicago.

Having resolved its debt crisis, demonstrated surprising resilience amid the U.S. –led sub-prime mortgage meltdown and worldwide credit crunch, and seen its debt rating upgraded, Brazil is now in a better position than ever to attract investors from all over the world.

“The investment grade will be important to the local asset management market because we will have much more access to institutional investors, private banking clients, endowments and foundations,” says the NAIB’s Brazuna.

Flávio Pires, Itaú’s head of institutional investment, puts it even more succinctly: “Today everybody wants to invest in Brazil.”