Brazil has some of the highest interest rates of any major emerging-markets economy, a legacy of the country’s hyperinflationary past. The situation vexes consumers and companies alike and has prompted the authorities to impose capital controls. But for one local manager, high rates spell opportunity.
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Olimpia Partners, a São Paulo–based fund manager and advisory firm, specializes in extending credit to small and medium-size businesses. Many of these companies are starved for capital. The Banco Central do Brasil’s key short-term policy rate, the Selic, stands at a lofty 12 percent. Corporate lending rates can range as high as 40 percent. In today’s fast-growing business environment, Brazilian banks are unable to keep up with the demand for credit, a fact that’s likely to keep rates elevated. “This has always happened in Brazil and is a trend that will not change over the next five to seven years,“ says Eduardo Menge, a portfolio manager at Olimpia.
For many midsize companies, the situation is even worse. Few of them have access to the capital markets. They can’t issue bonds on the international markets or raise equity at home. This provides Olimpia with its entrée. The firm’s $30 million OP Brazil Credit Fund makes privately negotiated secured loans to companies with annual sales of $50 million to $100 million.
Olimpia launched the fund in 2008, when many other direct lending funds in Brazil were imploding. The strategy isn’t unique, but to succeed it requires that managers have experienced credit and risk analysis and in-depth understanding of the borrower pool. So far, so good. The fund generated net returns of 12.74 percent in 2009 and 12.21 in 2010 for the international investors who held its dollar-denominated shares. Returns for the fund’s real-denominated domestic investors were higher still: 14.71 percent and 16.47 percent, respectively.
“The strategy delivered a short-duration, high-yielding return stream at considerably less risk than high-yielding alternatives in the U.S.,” says portfolio manager Menge.
The credit strategy helps investors avoid the high volatility that’s often characteristic of emerging markets. “One year investors focused on EM could get 30, 40 or 50 percent returns, only to be down the following year by 20 or 30 percent,” Menge says. “Big returns have come with high volatility.” Brazil’s Bovespa stock index, which plunged by more than 50 percent during the 2008 crisis only to regain that ground in 2009, has traded sideways to slightly lower over the past 18 months.
Arbitraging credit rates may seem like a business with few barriers to entry, especially for foreign lenders with deep pockets. Not so, says Menge. Lenders have to be able to visit borrowers frequently, perform on-site due diligence, maintain contacts with local lawyers and carefully monitor the health of borrowers and their loans. “Lending, especially of such a localized, specialized nature, can only be done if you are based in the country where you are investing,” he says. “Doing this outside of Brazil keeps you too far away from the borrowers and the conditions they operate under — conditions that are constantly in flux.”
