Pimco Love Affair Rekindled After Gross Spurning: Brazil Credit

Apr 22, 2014 8:07 pm ET

April 23 (Bloomberg) -- It didn’t take long for Pacific Investment Management Co. to be lured back to Brazil.

Three months after co-founder Bill Gross said the country was no longer a preferred market, Deputy Chief Investment Officer Mark Kiesel wrote last week that a plunge in Brazil’s government and corporate bonds has made them attractive again. Kiesel, one of six fund managers promoted after former Chief Executive Officer Mohamed El-Erian resigned in January, says he sees opportunities in sovereign notes and debt from companies including Petroleo Brasileiro SA and Itau Unibanco Holding SA.

Gross soured on Latin America’s biggest economy in January after President Dilma Rousseff’s spending binge failed to boost growth and fanned inflation, sparking debt losses last year that were double the developing-nation average. The shift by the world’s biggest bond fund manager reflects a rebound in Brazilian assets in the past month as speculation emerges that Rousseff will alter policies before October elections as her approval ratings sag.

“Among emerging markets, Brazil has been the poster child both in the boom years and now to the other extreme, where people got so pessimistic and almost went 180 degrees in the other direction,” Bryan Carter, a money manager at Acadian Asset Management, which oversees $300 million of fixed-income assets in emerging markets, said by telephone from Boston. “Just as we maybe got too optimistic several years ago, now we’ve gotten too pessimistic. That’s pretty clear.”

‘Inflation Concerns’

Gross, who said Brazil was no longer a preferred emerging market at the 2014 ETF Virtual Summit on Jan. 15, reduced Brazilian bonds and cash equivalents to 2.88 percent of his $232 billion Total Return Fund at the end of the first quarter, from 4.18 percent six months earlier.

The fund has lost 1.56 percent in the past year, trailing 89 percent of like funds in that span, according to data compiled by Bloomberg.

“Modest exposure to Brazilian local interest rates as yields rose on inflation concerns” resulted in negative or neutral returns for the Total Return Fund in 2013, according to Pimco’s Dec. 31 quarterly investment report.

Other funds run by Newport Beach, California-based Pimco that blamed Brazil for hurting returns last year include the Pimco Low Duration, Pimco CommodityRealReturn Strategy, Pimco Unconstrained and Kiesel’s own Pimco Diversified Income Fund.

Bonds Sink

Brazil’s dollar-denominated bonds lost 11.2 percent last year, the worst since 1998 and more than double the average drop of 5.3 percent in emerging markets tracked by JPMorgan Chase & Co.

Kiesel said in an April 14 research report on Pimco’s website following a trip to Brazil that traders are “pricing in rate hikes that are unlikely to materialize over the next few years,” making local debt attractive.

Interest-rate swaps show the central bank will raise the benchmark lending rate to about 13 percent by June 2015 from 11 percent, data compiled by Bloomberg show. Policy makers lifted borrowing costs this month for the ninth straight meeting as they seek to stem inflation that has exceeded the country’s 4.5 percent target since September 2010 and fueled street protests last year.

“We continue to mine opportunities for investments for our clients in Brazil, across sovereign credit, foreign exchange, local rates and corporates,” Michael Gomez, head of emerging markets at Pimco, said in a statement e-mailed by Mark Porterfield, the firm’s spokesman. “Particular value exists at this moment in the local rates side.”

Election Polls

A 3.9 percent jump in the real in the past month has helped bolster returns on local-currency government bonds. The notes have gained 5.8 percent in that span, bolstering gains to 13.2 percent since the end of January.

The Ibovespa index of stocks has jumped 15.6 percent from a five-year low set March 14.

The rebound comes after Rousseff’s election support fell to 37 percent this month from 40 percent in March in an Ibope poll posted on the website G1 last week. That followed a Datafolha survey this month that showed the government’s approval rating fell to 36 percent from 41 percent in February.

“The team felt that government approval ratings had deteriorated so much as a result of protests over rising prices, poor public services, a deteriorating fiscal deficit and government over-reach that negative opinion polls could be a positive catalyst for change,” Kiesel wrote.

Pimco ‘Premature’

During Rousseff’s three-and-a-half-year-old tenure, growth has decelerated to the slowest pace for a president since Fernando Collor, who resigned in 1992 on corruption allegations. Her bid to revive the economy by boosting spending has stoked inflation that the central bank says has a 40 percent chance of exceeding the 6.5 percent limit of Brazil’s target range this year and fuel the biggest budget deficit on record in 2013.

“The trend for the next six months is for inflation to remain high and for the government to keep responding with higher interest rates and currency intervention to tame it,” Marco Aurelio de Sa, the head of fixed-income trading at Credit Agricole SA’s Miami brokerage unit, said in a telephone interview. “Maybe Pimco’s bet is premature. If you think of it as a short-term trade, it makes sense. But to build a position thinking of the medium term, it’s premature.”

Kiesel said bonds from state-oil producer Petrobras, Itau and Banco Bradesco SA, Latin America’s largest private banks by market value, are attractive after they underperformed U.S. investment-grade peers to start the year.

Fuel Prices

After the cost to protect bondholders of Rio de Janeiro- based Petrobras against default soared to a five-year high of 2.36 percentage points over U.S. investment-grade debt on March 12, the premium has decreased to 1.81 percentage points, data compiled by Bloomberg show.

Brazil’s government will probably allow Petrobras to increase domestic fuel prices after the election, boosting revenue, according to Kiesel.

A Petrobras official who asked not to be named in accordance with corporate policy declined to comment on the timing of possible fuel price increases or the performance of the company’s notes.

“Sentiment was so negative that markets had likely overshot and could improve from depressed levels given that relative value had finally become attractive,” Kiesel, Morningstar Inc.’s 2012 fixed-income fund manager of the year, said in the report last week. “The highly negative sentiment was overwhelming the market’s pricing of risk.”

--With assistance from Ye Xie in New York and Alexis Leondis in Washington.