Sept. 16 (Bloomberg) -- Banco Bradesco SA, Brazil’s second- largest non-government bank, and Portugal’s Banco Espirito Santo SA formed a partnership to run private equity funds in Brazil as Latin America’s largest economy emerges from a recession.

The banks will start with a 500 million-real ($277 million) fund, BES’s Manuel de Sousa said in an interview in Sao Paulo. Each partner will invest 50 million reais to start the fund, he said. Sousa will head the new company that will be called 2bCapital, he said.

“We see clear signs of recovery in the Brazilian economy,” said Sousa. “Brazil and China are on top of investors’ priority list.”

The Bradesco-BES venture is part of a pickup in the formation of private equity, real estate and corporate debt funds that Jose Luiz Osorio de Almeida Filho, a former chief securities regulator, said is building. The central bank cut the benchmark lending rate to a record low of 8.75 percent in July to bolster growth, sapping demand for government bonds.

Investors pulled 7.8 billion reais ($4.3 billion) from funds tied to interest rates this year, reducing their portion among total fund assets tracked by Brazil’s investment association to 14 percent, the lowest level on record. Hedge funds, asset-backed commercial paper funds, stocks and fixed- income funds attracted money after policy makers cut rates five times this year, according to the association, known as Anbid.

‘Risky Funds’

“It’s a natural stage for the development of a market that has never seen rates this low and is kicking off an economic recovery,” Osorio, who oversees about $121 million in stocks and private equity as founder of Jardim Botanico Partners in Rio de Janeiro, said in a telephone interview. “Managers will have to offer more risky funds, and the regulator has the responsibility to make sure investors know the risks.”

The first fund from Bradesco and BES will invest in companies with annual revenue of more than 100 million reais and high growth potential, Bradesco and BES said in a joint e-mailed statement. The fund may acquire minority or controlling stakes, the banks said.

The fund will focus on companies linked to domestic consumption, health, engineering, logistics and agricultural machine makers.

2bCapital

2bCapital will seek to raise between 40 percent and 60 percent of the fund in the next year, including the 20 percent Bradesco and BES are investing jointly, Sousa said. The private equity venture starts its operation with three employees that come from BES’ private equity team in Brazil. 2bCapital plans to add seven other employees.

Banco Pine SA, a Sao Paulo-based bank, and Global Emerging Markets agreed to create a $250 million private equity fund to invest in mid-sized Brazilian companies, according to a regulatory filing.

Comissao de Valores Mobiliarios, the Rio-based securities commission known as CVM, said last month it is analyzing new rules for regulating Brazil’s 1.3 trillion-real mutual-fund industry because lower interest rates may prompt managers to take on too much risk. The concern is “justified” because money managers will buy more difficult-to-trade assets and hedge funds will increase the use of derivatives, securities whose price is determined by the value of another asset, said Osorio.

Brazil’s central bank slashed the benchmark lending rate from a two-year high of 13.75 percent in January. Gross domestic product grew 1.9 percent in the second quarter, powered by domestic demand.

‘Lose Volumes’

Investments tied to interest rates “will lose volumes and part of the money will go to fixed-income funds with a focus on private credit, and the rest will go to hedge funds and stocks,” said Regis Abreu, vice president of the nation’s Association of Capital Market Investors. “In an environment of lower rates it’s reasonable to believe they will add more risk and make more long-term investments.”

Latin American fund managers are gathering today for an annual conference organized by Informa Plc at the Ceasar Business hotel in Sao Paulo to discuss investment strategies.

Maria Helena Santana, Brazil’s chief securities regulator, said at an event last month that she is concerned about funds buying less-traded assets to boost growth because many managers are inexperienced in that type of investing. The CVM is analyzing ways to force fund managers to disclose more details of their holdings, she said.

“The concern is that investors are used to low risk and high profitability by buying government bonds,” Santana said at the event in Campos do Jordao in Sao Paulo state.

Debt Shift

Government real-denominated bonds have returned 8.7 percent this year after posting an average annual return of 15.2 percent over the previous five years, according to data compiled by JPMorgan Chase & Co. Brazil’s 8.75 percent benchmark rate is down from 16.25 percent five years ago and 19.5 percent a decade ago.

Fixed-income money managers probably will shift holdings to corporate debt from government bonds to boost profitability, said Abreu, who oversees $1 billion in assets for Rio-based Mercatto Investimentos. Hedge funds will also cut holdings of government bonds and increase the use of derivatives to bolster returns, Osorio said.

Hedge funds, known as multimercados in Brazil, pulled in 22.4 billion reais this year, attracting the most of any fund group and pushing the total invested to 310.7 billion reais, according to Anbid. Funds that invest in stocks added 1.1 billion reais this year, fixed-income funds attracted 7.7 billion reais and asset-backed commercial paper, known as FIDC in Brazil, had 18.4 billion reais in inflows, Anbid data show.

To contact the reporter on this story: Alexander Ragir in Rio de Janeiro at aragir@bloomberg.net; Francisco Marcelino in Sao Paulo at mdeoliveira@bloomberg.net

Last Updated: September 16, 2009 10:35 EDT