It is a challenging environment to manage money in Brazil given the political and economic turmoil. However, firms with strong history and management continue to find opportunities. One of these firms is JGP, a Rio-based asset management firm. I had the opportunity to meet with James Eckrich at their beautiful offices in Rio. While the firm was founded in 1998, James joined in a few years ago after stints in New York and London. The firm runs hedged and unhedged equity long biased strategies. Here are some of my thoughts and observations from our meeting:
Brazilian equity markets boomed in 2007-2008, and then again in 2010 in conjunction with the global commodities boom. The markets saw significant inflows from foreign investors. However, Brazil did not use the time to fix its pressing challenges. It continued in its reckless spending, and corruption continued. The current scandal engulfing politicians and Petrobras will continue to deepen.
In the subsequent years, foreign investors have suffered. Many have pulled their allocations to Brazil. Few institutional investors are talking about adding to their positions, but given the underperformance, these investors are starting to take a closer look. If the opportunity is not now, it may be getting close (2016 or 2017?). JGP clearly sees a trend among investors for wanting country or region specific allocations. Many institutions are focusing on Asia first, and then on Latin America as a secondary allocation. The market in Brazil is not that deep, with between 100-200 investable names.
A weak currency has created significant challenge for foreign investors—the Brazilian Real has dropped more than 25% in the past year. It is possible that the currency is reaching a low point that will allow investors to ignore currency and simply focus on valuations. Inflation remains stubbornly high at around 8.5%. The economy is expected to contract by more than 1% in 2015.
As in all countries, the eyes of financial markets rest on the Central Bank. Brazil is likely approaching the end of its rate hikes by the Central Bank of Brazil. The bank raised the benchmark rate 50 basis points to 13.75 in its last meeting in June. Many participants expect perhaps another 25 or 50 basis points before topping out. High rates have attracted capital from local investors—it is hard to compete with 13% returns in fixed income.
The political situation is quite fragile. Brazilian President Dilma Rousseff has low public approval and there is a threat of impeachment as the Petrobras corruption scandal continues to sink many in her party. Although she was re-elected in 2014, there is considerable chance that she does not remain in office until her term expires in 2018. While the market did not like Rousseff’s re-election, the markets embraced her selection of Joaquim Levy as Finance Minister, as he has been a proponent of austerity and reform.
Rousseff has been forced to move 180 degrees from the economic views of her first term in office. This change in approach has been necessary in order to protect Brazil’s investment grade credit rating. A simple Google search about the Petrobras bribery and corruption scandal shows the depth of the problem that may ultimately threaten the President. While politics currently look cloudy, the market may begin to look to the new President when campaigns start in earnest in 2017.
Corruption has always existed in Brazil, but the scale of the current scandal is troublesome. On the positive side, the corruption has reached a point to where the populace says that we can never let this happen again. This scandal will ultimately strengthen transparency, oversight, and the checks and balances within the system.
Given the political and economic uncertainty facing Brazil, it is difficult for a money manager to be fairly judged in the short-term. However, investors that can look through the volatility of the next five years may be handsomely rewarded.
Special thanks to Brennan Staheli, Michael Willden, Joshua Cooper, and the Lunt Capital team for their contributions to this report.