Brazil Battered by Scandal and Recession

12/14/2015 - 08h55

Advertising

ATTRACTA MOONEY

"FINANCIAL TIMES"

Fund managers that specialise in a single country usually find something positive to say about it, even if it is in the depths of a recession.

But not so for Brazil, the country where portfolio managers, like local politicians, businessmen and citizens, have been left scratching their heads about the nation's economic and political future.

Brazil is not the only emerging market economy to have had a turbulent time this year, but the sheer scale of turmoil has been exceptional.

During 2015, the world's seventh-largest economy slipped into recession, unemployment soared and Standard & Poor's stripped Brazil of its investment-grade credit rating.

Its politicians and leading businessmen have been embroiled in a scandal surrounding state-backed Petrobras, the oil company and President Dilma Rousseff faces impeachment proceedings.

As the chaos has taken hold, fund managers have retreated from Brazil in droves. Although they see a small number of bright spots, such as exporters and parts of the fixed income market, portfolio managers also fear the impact of political and economic instability on returns.

Lionel Bernard, who manages the Equity Latin America and Equity Brazil funds at Amundi, Europe's largest listed asset manager, says: "The strongest conviction I have at this point is that we will not have an [economic] improvement until we have a new political majority in Brazil."

The performance of Mr Bernard's Brazil fund has fallen 36.7 per cent in the first 11 months of the year, marginally underperforming its benchmark.

During the third quarter, Brazil - once regarded as one of the world's growth engines - suffered its sharpest contraction in growth since a new gross domestic product calculation system was introduced in 1996, a fall of 4.5 per cent.

Some commentators suggest its recession could turn into a depression. The country's stock market has plunged more than a quarter over the past year.

"The economic and political backdrop [in Brazil] is continuing to deteriorate with no clear resolution in sight," says Will Ballard, head of emerging markets at Aviva Investors, the UK asset manager.

Mr Ballard, like several other fund managers invested in Brazil, including Invesco Perpetual and Amundi, has reduced his exposure to the country this year. Last year, 8 per cent of Aviva Investors' Emerging Market Equity Income fund was invested in Brazil; this has now dropped to 3.5 per cent.

"The economy is in a terrible state," Mr Ballard says. "This is exacerbated by paralysis at the political level."

JPMorgan Asset Management has also decreased its allocation to Brazil by five percentage points this year, says Sophie Bosch, Latin America portfolio manager at the US fund house.

Claudia Calich, manager of the emerging markets bond fund at M&G, the UK fund house, says: "It is impossible to trade the daily noise and headline risk [in Brazil]."

However, she says there are "selected opportunities" in the country among exporting companies, which have benefited from the depreciation of the real. The value of the local currency has plummeted by a third this year.

Mr Bernard has also invested in companies focused on exporting, such as Suzano Papel e Celulose and Klabin, both paper producers.

He adds: "A lot of sectors, such as banking and utilities, have attractive valuations right now, but we need political stability and fiscal changes in order to feel comfortable with the domestic market."

Investors believe political reform is needed for Brazil's investment outlook to improve.

Dean Newman, head of emerging market equities at Invesco Perpetual, says: "Until a sense of political stability is restored, there is a danger that company bosses may continue to delay investment decisions." The opening of new factories will be put on the backburner, he says.

Earlier this month, Brazil's stock market and currency strengthened on the news that the congress was initiating impeachment proceedings against Ms Rousseff. She stands accused of fiddling the public accounts.

Waj Hashmi, portfolio manager of the Emerging Markets Equities fund at Schroders, the UK investment group, says: "In the near term, the politics look quite murky and do not help the investment case."

Some argue that rather than pushing for an impeachment, politicians should instead try to rescue the economy. "There is still no consensus on whether [Ms Rouseff being impeached] would be good or bad for the Brazilian economy," says Xavier Hovasse, head of emerging equities at Carmignac, the French asset manager.

Other portfolio managers say recent events are a good sign for Brazil's long-term outlook. The fact that well-known politicians and businessmen, including the chief executive of BTG Pactual, the investment bank, have been arrested over the Petrobras scandal shows the judicial system works. This is not always the case in emerging market countries, says Mr Hashmi.

What portfolio managers do agree on is that steps to boost the economy need to be taken soon. Mr Bernard says: "Investment is stuck. Consumption is stuck. Both corporate and consumer spending are reaching new lows, so something has to happen. Otherwise the country is heading to a situation similar to Argentina [which defaulted in 2014], which I don't think will be allowed to happen."

Mr Bernard hopes a "sense of urgency" in 2016 will spur the Brazilian government into action. But most fund managers expect the economy to continue contracting.

"We think the recession is far from over," says Lajla Aganovic, who runs the Emerging Consumer fund at Lombard Odier, the Swiss asset manager.

Ms Bosch remains hopeful about the country's long-term outlook. "We believe Brazil is in an economic recession, not an economic crisis. It is the political situation that is in crisis and [that has] deteriorated confidence, stalled private investment and increased market volatility," she says. "But under our eyes, we like what we see. We are very optimistic in the long term."

Petrobras was once the jewel in Brazil's corporate crown, but not any more. The state-owned oil company stands accused of colluding with contractors to inflate bids - with contractors allegedly giving kickbacks to Petrobras officials and politicians.

Leading businessmen and politicians have been caught up in the scandal, including André Esteves, the billionaire banker (pictured).

Mr Esteves, who built BTG Pactual from a shell into Brazil's top independent investment bank, was detained last month on suspicion of attempting to interfere with the Petrobras investigation. Delcídio do Amaral, a Brazilian senator, was arrested at the same time. Both deny any wrongdoing.

However, in the wake of his arrest, Mr Esteves ceded control of BTG, which also includes an asset management division, to seven other partners.

The banker, who was born in Rio de Janeiro and is estimated to be worth more than $2bn, was formally charged with obstruction of justice last week. The bank's share price has fallen by half since his arrest on November 25.

Eduardo Cunha, the speaker of Brazil's lower house who this month started impeachment proceedings against Dilma Rousseff, the country's president, is also being investigated in the Petrobras probe. He has been charged with corruption and money laundering, which he denies.

Copyright The Financial Times Limited 2015