Brazilian hedge funds trounce competition
By Alexander Ragir,
They arrive every week, in ones and twos and groups of 10, some of them coming straight from Sao Paulo, Brazil’s international airport. These investors head for the dark-wood halls of Credit Suisse Hedging-Griffo as supplicants, asking to put their millions into one of the world’s top-performing hedge funds.
The answer from the fund’s managers is often a polite but firm no. Hedging-Griffo’s Verde fund has returned an annualized average of 33 percent since 1997. One American offered to sign a contract that wouldn’t allow him to ask for his cash back for three years, says Luiz Paulo Parreiras, strategist for the firm.
“Pension funds, endowments, sovereign-equity money — we’ve turned all of them down,” he says. The money managers are concerned that if Hedging-Griffo’s $8 billion fund becomes too large, its trades may move Brazilian markets.
Hedging-Griffo’s high returns in the past decade lead the pack in Latin America’s largest country, and other Brazilian hedge funds — many of them open to new investors — aren’t far behind. Americans and Europeans are beginning to notice.
The Eurekahedge Latin American Onshore Hedge Fund Index — 90 percent of which is composed of Brazilian firms — had an average yearly return of 20 percent from 2001 to 2010, the best in all regions of the world, according to Eurekahedge.
The irony is that trading strategies by most Brazilian hedge funds are similar to those of indexed mutual funds. Brazilian managers put almost all of their money into bonds and stocks. Brazilian regulators call hedge funds multimercado, or multi-strategy, firms to differentiate them from mutual funds.
Unlike the unregulated pools of capital in the United States, hedge funds in Brazil report their asset values daily to regulators. They also have to disclose their holdings and typically must be able to meet redemptions within days of when investors ask for their money, inhibiting them from making many risky bets.
That means Brazilian hedge funds are relatively easy to manage, says Simon Nocera, co-founder of San Francisco-based hedge fund Lumen Advisors and a former economist at the International Monetary Fund.
“All you have to do is buy the Bovespa stock index and government bonds,” he says. “It’s not like you have to be super active or a great trader.”
Investors aren’t complaining. Brazilian funds have been profitable because in the past 10 years, the nation’s government bonds and stocks have beaten the returns of most indexes in the world. Fiscal austerity, record exports and rising incomes have fueled the boom.
A two-year Brazilian government bond has posted an average yearly return of 17 percent since 2001. Brazil’s Bovespa stock index rose by 16 percent a year in that period compared with a 1 percent gain for the entire period by the Standard & Poor’s 500-stock index. Globally, hedge funds gained 11 percent annually in that period, according to Eurekahedge.
Brazil’s economy grew 7.5 percent in 2010, its fastest pace in two decades. The heated growth is creating a new class of wealthy investors. From 2006 to 2009, 38,000 Brazilians became millionaires in U.S. dollars — that’s 26 every day — according to Bank of America.
In October, Highbridge Capital Management, the New York-based hedge fund controlled by J.P. Morgan Chase, spent an undisclosed amount to buy a controlling stake in the $6 billion fund management firm Gavea Investimentos.
Brazilian analysts, traders and former investment bankers have opened 31 new hedge funds in the past year, according to Economatica, a Sao Paulo-based research firm. The country has 462 hedge funds.
As the economy expanded, the excess of cash spurred accelerating inflation, along with a 39 percent increase in the value of the real, Brazil’s currency, against the dollar, in the two years that ended April 29. Brazilian bonds rallied as the nation received its first investment-grade rating in 2009. Brazil’s central bank has raised overnight bank lending rates three times this year, to 12 percent, in an effort to cool off the boom.
The skyrocketing currency and faster inflation raise questions about whether returns will continue at the same pace, says Jim O’Neill, chairman of Goldman Sachs Asset Management in London.
“It’ll be hard to match the past decade,” O’Neill says.
‘Brazil kit’ strategy
The common Brazilian hedge-fund strategy, dubbed the “Brazil kit” by fund managers and traders because it’s so simple, holds about 66 percent in bonds and most of the rest in stocks, along with some bets on currency or Brazilian interest rates, regulatory filings show.
Investors pay Latin American hedge funds the same fees that are common in the United States and Europe. They charge an average of 1.88 percent of assets and 20 percent of profit.
Wealthy Brazilians demand that managers consistently beat returns on government bonds, says Marcelo Mesquita, co-founder of Leblon Equities Gestao de Recursos, a private-equity firm. Many fund managers are so concerned they’ll trail bond profits that they miss the best equity bargains, he says.
“They shouldn’t be getting paid the 2 and 20 if they aren’t taking risks,” Mesquita says. “You pay someone to judge the risks to get a higher return.”
Strategists have few choices in Brazilian stocks. The Bovespa stock exchange lists 467 companies compared with 5,700 traded in the United States.
Cesar Stange, a partner at Gaia Capital, says he has put client money in Brazilian hedge funds for seven years. “The spectrum of strategies is smaller,” he says, “but there are some very clever managers.”
Some Brazilian managers have opted to take more risks by incorporating their hedge funds offshore. That allows them to get around government regulations. Tarpon Investimentos puts its money mostly in stocks of companies with strong growth potential, says Jose Carlos Magalhaes, who founded the firm at age 24 in 2002.
Investors in its offshore fund agree to allow Tarpon to hold their money for two years. The fund has beaten most hedge funds in Brazil in nine years. Tarpon HG Fund-A posted a five-year annualized return of 30 percent from 2005 to 2010.
Not one Brazilian hedge fund collapsed in the global subprime financial crash that began in late 2007, says Maria Helena Santana, president of a regulatory agency.
That crisis — caused largely by the $2.5 trillion that banks, insurance companies and hedge funds held in securitized subprime debt — destroyed 2,494 funds globally in 2008 and 2009, according to Chicago-based Hedge Fund Research.
Brazil requires managers to report to independent risk-assessment companies, in some cases every week.
“It makes all the difference if you have more transparency,” says Luis D’Amato, head of institutional products at Hedging-Griffo. “In the U.S., whenever you got the info, it was too late.”
The European Commission is using regulations similar to Brazil’s for a new class of hedge funds known as UCITS. The rules for UCITS require managers to report investment holdings and restrict the use of loans to buy securities. These funds must allow clients to withdraw assets in as little as one day. UCITS tripled in assets to $90.5 billion last year, according to Hedge Fund Intelligence.
New generation of managers
In 2007, Zurich-based Credit Suisse Group bought a majority stake in Hedging-Griffo for $364 million.
“They try to hire young people,” says Parreiras, the strategist. “I’m really like the new generation within Credit Suisse Hedging-Griffo.”
In the 1990s, the proprietary trading desks at Brazil’s largest investment banks, such as Banco Garantia and Banco Pactual, trained the country’s top traders.
Hedging-Griffo, Brazil’s largest hedge fund, differs from others because of its long track record, Parreiras says. The Verde fund is one of the oldest in Brazil. It has weathered several crises, including the 1998 financial contagion that started with Thailand’s currency devaluation and Argentina’s bond default in 2001.
“Running risk within that environment proves that people have to work for the money,” he says. “You can’t just buy a ‘Brazil kit’ and go home.”
With $8 billion under management, the hedge fund cannot get any bigger without moving bond markets, he says.
Newer, smaller funds have had similar success. Among them is Tarpon.
In the throes of a financial crisis in Brazil in 2002, Magalhaes knocked on the door of his boss, Ricardo Semler, chairman of Semco, and asked for money.
Magalhaes says stock prices were too inexpensive to pass up. That turned out to be a profitable decision. Semler’s money has grown 17-fold from the fund’s inception to mid-May.
One of Magalhaes’s first investments was in Sadia, a Brazilian poultry processor. He had five Tarpon analysts studying how this transition would bolster cash flow, says Eduardo Mufarej, Tarpon’s chief executive.
Keeping analysis narrowly focused is one of Magalhaes’s philosophies. Almost everyone, including himself, is exceptional at no more than 5 percent of the things he or she does, he says.
“I don’t believe in great ideas,” he says. “We are not Thomas Edison inventing light bulbs.”
By July 2004, Tarpon had funneled $52 million into Sadia, which represented 35 percent of the hedge fund’s assets. Brazil doesn’t restrict the amount that a fund can put in one company.
By 2005, Tarpon decided Sadia made bad decisions when it began exporting and spending too much money to increase production capability, he says. So it sold its shares, making five times as much as it had paid to buy them, Mufarej says.
Three years later, as stocks plummeted, Tarpon sought bargains to spend its cash on. It took another look at Sadia. The company had made wrong-way currency hedges leading to 760 million reais in losses. The stock fell by more than 70 percent in two months after the company announced those trading results.
Sadia accepted a takeover offer in 2009 from competitor Perdigao. Magalhaes had his staff analyze projections of the merged companies, he says. Two months later, Tarpon was among the largest investors in a share sale valued at $2.8 billion as part of the takeover.
The new company became Brasil Foods. By December 2010, it was the world’s largest poultry exporter. As of March 31, Tarpon owned Brasil Foods stock valued at $1.1 billion, its biggest investment, representing about 32 percent of the firm’s assets.
The full version of this article appears in the July edition of Bloomberg Markets magazine.