Opinion – Grain in Grain: These four charts show you how to invest in fixed income

The intense deflation that occurred in the last three months, together with the interest rate hike implemented by the Central Bank, confused investors about where to invest in fixed income. The charts below guide you on how you should think about your fixed income portfolio.

Usually, investors are driven by the yield that is seen in the short term. This occurs due to the natural difficulty of making projections and the lack of knowledge of what is normal.

As we do not know what a normal return is, we assume that what has recently occurred is what naturally should continue to occur. However, care must be taken not to fall into this trap.

The charts below are intended to give investors insight into how to conduct their fixed income investments.

First, let’s identify the problem.

The graph above shows the evolution of the CDI and of the index of public securities referenced to the IPCA with maturities of less than five years, the IMAB5.

In 2022, the IMAB5 appreciated by 8.33%, against the 9.67% return of the CDI. The difference is not very big, but in the last 4 months it has become huge.

From June to September, the CDI yielded 4.36%, but the IMAB5 appreciated only 0.77%.

At this point, the natural thing for the investor is to extrapolate the results. Therefore, many want to throw away IPCA-linked securities and exchange them for CDI-linked assets.

Beware of this decision.

In the chart above, the upper panel shows the evolution of the Selic Target defined by the Central Bank and the IPCA since 2009. In the lower panel, there is the evolution of the difference between the Selic and the IPCA.

Note that the Selic does not usually spend a lot of time with a rate 5% higher than the IPCA. Therefore, be careful when making long-term decisions with a view to taking advantage of Selic. This effect must be ephemeral. Soon this difference can drop to 4%. Either with the fall of the Selic or with the rise of the IPCA.

The sustainability of the recent drop in the IPCA is still not accepted by many. It was provoked by tax incentives that must be reversed.

Additionally, world inflation is high and there is a risk of contagion through international parities. This is pointed out in the graph above. It is possible to follow the evolution of the IPCA and the American inflation index, the CPI.

It is unlikely that our inflation will remain low if the developed world maintains high inflation.

Thus, it is necessary to separate the short-term portion of the long-term portion in your investments.

The graph above shows the evolution of the IMAB5 and the CDI since 2003. In this period, the IMAB5 appreciated by 906% and the CDI by 586%. Those who invested R$ 100 thousand in 2003 in IMAB5 would have R$ 1 million today. The same investment in CDI would result in R$ 686 thousand.

Therefore, for short-term investments, that is, up to two years, the CDI should continue to be more attractive, considering the balance of return and risk. However, for longer maturities, IPCA-referenced securities should outperform. Thus, the rule is to have a balanced fixed income portfolio.

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

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