Best of Brics crown is up for grabs

Brazil - Reinaldo Le Grazie, CEO, Bradesco Asset Management 

High inflation, low growth and corruption scandals are dominating headlines in Brazil but huge investment opportunities are emerging as value investors and bargain hunters start to cherry pick oversold and underweight fixed income and selected equities.

Indeed, beneath the noise lies a far more interesting investment story as it is clear Brazil represents a better destination for investor cash than its Bric peers. Russia is mired in deep economic and geopolitical woes, China is changing its growth model to something altogether uncertain, and for India, investors have already priced in the benefits of ambitious reforms into assets but the country is yet to deliver. 

Brazil is clearly different. The bad news is priced in and while any good news would be regarded as a fool’s promise, the nation’s new economic team is taking necessary tough measures to return Brazil to a path of growth by reducing macro risk, mainly through fiscal moves that will lead to lower interest rates and government debt in two to three years. 

Key investment opportunities stem from the real’s depreciation which brings upside potential. LatAm weightings in global
emerging portfolios are close to historical lows, 10 percentage points below average, while China and India’s blended yields are at 5.5 per cent and 4.2 per cent respectively, coming well below Brazil’s 7 per cent.

Brazilian assets are much cheaper today. Fixed income nominal rates and inflation-linked local currency bonds offer highly attractive returns in a market anchored by huge buy-to-hold pension funds.

In dollars, smart money would be wise to pick investment grade four-year corporate bonds paying 5.5 per cent. Many such examples abound, in particular in banking and foods. 

For equities in the short term, financials and pulp & paper stocks should benefit most due to strong balance sheets, high cash holdings, a weaker currency and high interest rates. In the medium term, infrastructure companies look promising. Brazilian stocks are becoming cheaper amid expectations that discount rates will drop and growth will resume thanks to lower macro risk.

Brazil is oversold and its macro risk overstated. For example, external non-financial corporate debt amounts to $120bn (€113bn), just one third of the government’s foreign reserves and almost fully covered (94 per cent) by the central bank’s hedging programme. Total gross external debt is $10bn lower than foreign reserves and offers the highest diversification for emerging market investors. 

And yet Brazil’s five-year credit default swap is trading at 290 basis points, almost 140 basis points above the fair value for an
investment grade country, and higher than non-investment grade nations such as Hungary or Turkey. On top of this, the real, which enjoyed a strong 10-year run, weakened just as much as the euro or Colombian peso, dismissing the idea of a currency crisis. 

In terms of other misconceptions about Brazil, it is worth remembering the country has low exposure to China and that inflation is rising because of government-controlled prices and tax hikes, and not uncontrolled demand or central bank action.  

On the growth side, uncertainty will abate with transparency and commitment to sound fiscal performance ultimately spurring confidence. The weakening currency will provide some relief to fiscal and monetary tightening, helping regain some competitiveness. The average wage in dollars is back to 2006 levels, for example. 

For the future, gains are expected to come from infrastructure development. Banks and capital markets are ready for channeling global savings into solid investment projects, sharing risks and lowering funding costs once macro risk abates. At the micro level, tax reform, business simplification measures and price-tariff realism for utilities will boost confidence, providing further opportunities for investors.  

Manuela D'Onofrio, Unicredit

China and India - Manuela D’Onofrio, Head of global investment strategy at UniCredit 

Our decision to underweight emerging markets (EM) in our equity portfolio goes back to the end of March 2013 when, with the announcement of impressive QE by the central bank of Japan, we decided to focus our portfolio on the equity markets of developed countries. At the beginning of this year, on the back of our strong belief that the ECB was very close to announcing QE, we then decided to further reduce our EM equity exposure to increase the eurozone equity position.

So in a nutshell, within a negative stance on the EM asset class, we decided to concentrate on countries willing to implement structural reforms and likely to benefit from monetary stimulus and this led us to the decision to invest only in India and China. 

In the past two years, we have been particularly negative on Brazil, whose political authorities appear to be reluctant to implement the reforms necessary to reduce public spending and to abandon the old fashioned strategy to win consensus through welfare populism. We believe Brazil used the positive economic trend of the past, mainly driven by the epic China-led commodity boom, to develop a too generous welfare system that, in the current environment of weak commodities demand, is no longer sustainable. Although the current level of Brazil external debt does not represent a threat to its short and medium-term financial stability, the government habit of raising minimum wages at a faster pace than productivity will continue to fuel inflation forcing the central bank to implement a tight monetary policy even if the economic activity is doomed to decline further.

On the contrary, we believe the Chinese authorities are fully committed to rebalancing the economy, in order to make it sustainable in the medium and long term. This rebalancing will require further steps toward market liberalisation and a sound banking system. We also believe the Central Bank of China will provide the necessary monetary stimulus as the central government implements measures aimed at digesting the huge debt accumulated by local governments in the past.

The substantial decline in the oil price, which we expect to remain low until the end of the year at least, will provide a further boost to the economy of big oil importers such as China and India. 

Our positive stance on India is based on the confidence we have in the ability of the present government to implement pro-business reforms and to deliver the recently announced big infrastructure investment plan. The decline in the oil price should be conducive to lower inflation and, therefore, lower interest rates.

Russia has been hit by two hard rocks at the same time: the economic sanctions inflicted by the US and the eurozone over the Ukraine crisis and the sharp decline of the oil price. 

In relation to the geopolitical tension, we believe Russia will not give up its quest to extend its control of the eastern Ukraine regions so a compromise does not appear to be at hand. Furthermore the oil price will at best stabilise at current levels as a pickup in demand is difficult to envisage in the near term.

It is true both the Brazilian and Russian equity markets trade at low multiples but we believe it is for good reasons. Therefore we prefer to invest in China and India, the two markets that will continue to be supported by a more accommodative monetary policy and pro-business reforms.