Once-Popular Brazil Bonds Are Now Unloved Relic of Currency Wars

  • Real-linked bonds sold abroad lag behind Brazil's local notes
  • About $3 billion of the securities are still outstanding

The growing likelihood that a new government will take power in Brazil has spurred soaring investor demand for the nation’s bonds. Yet one corner of the country’s debt market has been largely ignored: $3 billion worth of notes sold to foreign investors.

The securities, which were sold between 2005 and 2012, had been popular because they allowed overseas buyers to benefit from the real’s appreciation without actually having to buy debt denominated in the currency, which would subject them to a 6 percent tax. The levy was part of what then-Finance Minister Guido Mantega called a “currency war” as nations sought to weaken their exchange rates to spur economic growth. Brazil was struggling to curb the huge flow of money coming into the country and pushing up the real. In 2013, it scrapped the tax as the economy faltered and the real slumped.

Now investors are piling back into Brazil on bets President Dilma Rousseff will be impeached, paving the way for a government that can revive growth. The lagging performance of the so-called real-linked bonds underscores just how unloved the notes have become. Yields on securities due in 2022 have dropped 0.5 percentage points this year, compared with a 3.8 percentage-point plunge for similar-maturity Brazil debt sold locally.

The real-linked obligation “is the heritage of a previous time,” said Viktor Szabo, who helps oversee $11 billion of emerging-market debt at Aberdeen Asset Management in London. “The local market is so much more important now.”

The real-linked bonds pay investors interest and principal in dollars, with payments varying based on the changes in the Brazilian currency. 

Historically, investors demanded significantly lower yields to buy the real-linked bonds than the domestic securities. That’s because the former are governed by New York law, meaning bondholders could sue in the U.S. in the event of a default instead of litigating in unfamiliar Brazil courts to recoup their money. The difference in yields between the notes is 1.2 percentage points now, down from an average of 2.7 percentage points in the past three years.

The lack of investor interest is making it harder to buy and sell the securities. After plummeting 33 percent last year, the real has gained 12 percent in 2016, the most among the world’s major currencies. The real gained 0.3 percent Monday to 3.556 per dollar as of 11:45 a.m. in New York.

“This market is almost forgotten,” said Julian Jacobson, a money manager at Fabien Pictet & Partners Ltd. who has invested in emerging markets since 1999. It has “evolved and more investors are willing to buy the local papers directly,” he said.

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