Opinion – From Grain to Grain: Brazil Risk reaches the same level as past crises and affects investments

The recent rise in Brazil risk was reflected in the various investments and caused fixed income and variable income to show negative returns in recent months. There are plenty of reasons to justify the elevation of this risk. The big question is whether this is the time to take advantage of it or if it could get worse.

How can country risk be measured?

Country risk can be measured by the derivative contract called Credit Default Swapbetter known by its acronym CDS.

CDS can be compared to the insurance premium you pay on your car. For example, if you own a R$100,000 car, you might pay a premium of around R$4,000 to protect yourself in case something happens to your car. Therefore, you pay 4% of the value of the car per year, to have the protection.

Brazil’s 10-year CDS is today at 422 points. In market parlance 100 basis points is equivalent to 1%. Thus, an investor wishing to protect US$ 100 million in Brazilian bonds from a credit event, pays 4.22% of this amount annually to have this protection.

The graph below shows the evolution of the CDS in Brazil since 2007. Note that the level of 400 points was only reached in four moments in this 15-year period.

Two of these crises were for external reasons. In 2008, there was the great global financial crisis due to mortgages and in 2020 there was the pandemic.

In the other two moments, internal factors were dominant. The year 2018 was the last presidential election and between 2015 and 2016 was the time of the last impeachment presidential.

Right now, there is a mix of internal and external factors causing the risk to rise.

How does risk affect investments?

The risk premium that investors pay to protect themselves from losses from a credit event is incorporated into the interest rate.

Although the CDS is an instrument to protect bonds Brazilian bonds, that is, Brazilian bonds issued abroad, the pricing of bonds in the domestic market also reflects this risk.

Therefore, the greater the risk, the more interest rates rise.

In the graph above it is possible to visualize this effect. The graph shows the evolution of the CDS (orange line) and the Brazilian 10-year interest rate (white line).

This effect penalized investors of fixed income securities in Brazil. Those who invested in IPCA-referenced bonds with a maturity of more than five years felt this.

The index that tracks the average return of federal public securities, Treasury bonds, with a maturity of more than five years is calculated by Anbima and is called IMAB5+.

IMAB5+ has yielded only 4% in the last three years. The chart below shows the evolution of this index.

Higher interest rates also affect all risky investments.

As Rodrigo Azevedo, CIO of Ibiuna, said in a recent presentation, Brazilian assets seem cheap, but they could get even cheaper.

As we have seen, the country risk is at a level similar to that of past crises. Who invested in these moments in the past, was rewarded in horizons of five years ahead.

However, as explained by Azevedo, the risk can increase even more, as happened in 2015. Thus, to benefit from this premium, the investor will need to be very cold-blooded to withstand volatility and short-term losses.

Michael Viriato is an investment advisor and founding partner of Investor’s House

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