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Brazil's High Interest Rates Sparks Rush Into Corporate Bonds

·4 min read

(Bloomberg) -- Just as tighter financial conditions induce a global credit rout, one of the countries that lifted interest rates the most is experiencing a market revival.

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Brazil’s local-currency corporate bond sales jumped 35% in the first five months of the year compared to the same period of 2021, according to data from the nation’s capital markets association. The surge is remarkable not just because it goes against a global trend -- corporate bond sales are down by 30% in the US in the same span, according to Bloomberg data, and high-yield debt issuance plunged 70% worldwide -- but also because Brazil interest rates have soared 11.25 percentage points since early 2021.

Companies are looking past the higher costs to sell debt as they seize on strong demand from local investors shifting to fixed-income assets after getting burned in the stock market. Retail investors and local funds bought 45% of the 32.7 billion reais ($6.3 billion) in local corporate bonds, known as debentures, sold this year, up from 38% in the same period of 2021.

“The rise in the Selic benchmark rate triggered a strong rush for fixed-income assets,” said Luiz Sedrani, chief investment officer at BV Asset in Sao Paulo. “On top of looking for interesting nominal yields, retail investors may be revising their investment profile after suffering with high volatility in other markets.”

Brazilian policy makers have moved the country’s key rate wildly in the past few years, taking it from 14.25% in 2015 to 2% in the depths of the pandemic and back to 13.25%. As the rate swung, so did investors, many of whom had flocked to stocks and hedge funds for the first time in search of higher returns as the rate fell. Now they are returning to fixed-income assets, particularly floating-rate local debentures that protect them from losses sparked by surging rates, as the central bank tries to stem inflation that’s running at more than 11% annually.

Between January and May, equity and hedge funds suffered 103 billion reais of outflows, while local-currency bond funds received 99 billion reais, according to Anbima data.

Downfall of Star Hedge Fund Reveals Brazil at Tipping Point

While a lot of the money being pulled out of stocks initially went to government debt, investors later turned to corporate bonds, which pay a premium. Funds dedicated to domestic corporate debt received 87 billion reais in the first five months of the year compared with just 12 billion reais for sovereign debt funds, a reversal of the trend seen in early 2021. Funds that buy foreign-currency debt, meanwhile, suffered 1.2 billion reais of outflows this year as overseas bond sales plummeted by 50%.

“Retail investors got hurt with stocks, hedge funds and equity funds over the past months and will probably take advantage of high interest rates to keep buying credit,” said Marcos Iorio, a Sao-Paulo based portfolio manager at Integral Investimentos, which has 8.9 billion reais under management.

The bet on corporate debt is paying off. An index of Brazilian local corporate bonds calculated by hedge fund JGP Asset Management returned 6.2% this year, compared to a 5.1% return of the benchmark DI rate. The Ibovespa stock index handed investors a 5.5% loss, while a Bloomberg gauge of Brazilian corporate dollar bonds fell 11.5%.

Among the companies that sold local debt this year are frequent issuers like Braskem SA, Rede D’Or Sao Luiz SA and Localiza Rent a Car SA, which tapped the market with deals topping 1 billion reais each. Less well-known names like real estate developer Eztec and healthcare service provider Kora Saude have also borrowed.

“There’s a large number of issuances from companies that never sold debentures,” said Artur Nehmi, a Sao Paulo-based fixed income manager at Sparta Fundos de Investimento, which oversees over 6 billion reais. “These new issuers can offer excellent opportunities but also non-negligible risks, so asset picking by money managers will be a big differential for returns over the coming months.”

Money managers say strong investor demand is allowing large companies to negotiate better costs even with rates on the rise. Credit spreads in Brazil normalized after a market crunch in early 2020, when record withdrawals from credit funds forced debt sales into a market with few buyers, distorting prices and borrowing costs. Before the correction, spreads were at historic low levels as a shortage of notes allowed issuers to squeeze costs.

Supply and demand dynamics are more balanced now, though slightly in favor of issuers, according to Laurence Mello, a Sao Paulo-based portfolio manager and head of private credit at AZ Quest Investimentos Ltda, which has 20 billion reais under management.

“Retail investors put their money in the credit market then moved to stocks and are back now to credit,” said Mello. “They are more conservative.”

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