Too Late to Sell, JPMorgan and Aberdeen Stick by This Big Loser

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  • Brazil's local-currency notes have lost 28% in dollars in 2015
  • Foreign holdings of real bonds little changed in September

After suffering the worst bond losses in the world, foreign investors could be forgiven for souring on Brazil.

Yet most are sticking with the embattled country, according to the latest data from Brazil’s Treasury. International investors’ holdings of the nation’s local-currency notes were little changed at 488 billion reais ($129 billion) in September, when Brazil was cut to junk and the real sank to a record low. This year, the amount they own has actually increased 20 percent, even as the securities lost 28 percent in dollar terms, the most for domestic bonds in major markets.

Aberdeen Asset Management Plc’s Viktor Szabo is one investor who has resisted the urge to flee as Brazil reels from the worst recession in a quarter century, soaring inflation and political gridlock. Exiting the trade now would only make matters worse, Szabo said, as it could mean missing out on the chance to recoup losses as the economic swoon eventually quells the surge in consumer prices.

The selloff in Brazil’s local debt is a big reason that Szabo’s Aberdeen Emerging Markets Debt Local Currency Fund had lost 12 percent this year through Nov. 4, more than the benchmark’s decline of 10.6 percent.

“It’s expensive to get out now,” he said. “You can expect a lot of volatility, but there’s a sufficient argument to stay in the trade.”

Pierre-Yves Bareau, who oversees $43 billion in investments as the head of the emerging-market debt at JPMorgan Chase & Co.’s asset-management unit, agrees.

“We’ve seen a lot of stress already,” Bareau said. “It seems late to panic now.”

Brazil accounted for 10.7 percent of the assets in JPMorgan’s $2.3 billion emerging-market local-currency fund as of Sept. 30, its largest investment, according to the company’s website. The fund has lost 12.5 percent this year, data compiled by Bloomberg show.

The relatively high interest rates on Brazil’s local debt is another reason foreign investors like Bareau and Szabo are loath to walk away from the country. With an average yield of 15.4 percent, the securities are too cheap to pass up in a world where $5.6 trillion of government securities offer returns below zero. 

“When you have a country offering double-digit yields in the short bonds and the ability to hedge the currency exposure, it makes sense” to own Brazilian debt, said Marcela Meirelles, the managing director of emerging-market sovereign research at TCW Group Inc. She declined to disclose her investment strategy.

The real has plunged 30 percent this year, the most in emerging markets, as President Dilma Rousseff struggles to fend off impeachment calls and the economy heads for what may be its longest contraction since the Great Depression. Standard & Poor’s, which stripped the country of its investment grade in September, predicts the economy will shrink 2.5 percent this year and another 0.5 percent in 2016. The currency gained 0.4 percent Friday to 3.765 per dollar as of 1:44 p.m. in New York.

Given the grim outlook, investors like Schroder Investment Management’s Jim Barrineau are content to keep Brazil’s local debt at arm’s length.

“The problem is their currency is probably set to structurally depreciate over time,” Barrineau, director of Latin American fixed income at Schroder, said from New York. “It’s a difficult one to argue that you should hold for the long term.’’

Still, for the foreign investors who own almost a fifth of Brazil’s domestic debt, the outlook isn’t all bad. The severity of the economic slump has analysts surveyed by the central bank predicting the inflation rate will drop to 6.5 percent -- the ceiling of the government’s target range -- by the next 12 months from 9.5 percent in September.

“Investors are giving Brazil the benefit of the doubt,” said Pablo Cisilino, a money manager at Stone Harbor Investment Partners LP, which oversees $35 billion in emerging market assets including Brazil bonds.