Thomas Lee/Bloomberg News, via Getty ImagesJoaquim Levy of Bradesco Asset Management predicted that investors would embrace new rate-setting standards.SÃO PAULO, Brazil — Investment benchmarks are meant to be stable, authoritative guideposts for sizing up assets and performance.
But as the recent scandal involving the London interbank offered rate, or Libor, has shown, traditional benchmarks can come under attack. Even ones that have proved reliable may become obsolete, especially in a rapidly changing emerging market.
In Brazil, a system that has been in place for decades may soon change and force fund managers to dive into riskier investments in order to meet performance goals.
Since the 1980s, most Brazilian asset managers have shaped portfolios, measured performance and assigned bonuses based on a single benchmark: Brazil’s interbank deposit certificate rate, known in Portuguese as the Certificado de Depósito Interbancário, or C.D.I.
Because of Brazil’s history of high inflation and high government debt, common global benchmarks for fund performance were for many years not relevant.
To attract wary investors, the government had to issue bonds whose yields automatically changed with the Central Bank of Brazil’s basic interest rate, ensuring attractive returns even after inflation. Both giant pension funds and individual retirees bought these bonds en masse.
To reflect this reality, in the 1980s the financial industry created the C.D.I. rate, a daily average of overnight interbank loans, which hovers close to the central bank’s basic interest rate.
The C.D.I.’s influence extends throughout the economy, where many other interest rates rise and fall with it on a daily basis. Bank certificates of deposit pay a percentage of the C.D.I., corporate debt pays a percentage of the C.D.I. or the C.D.I. plus a spread, and most of Brazil’s asset management industry uses it as its benchmark.
Currently, fixed-income and all-asset funds aim to beat the C.D.I., sometimes called the D.I. rate.
Aggressive hedge funds that leverage up and invest primarily in equity, corporate debt, currencies and derivatives take their 20 percent cut not on absolute profits, but on performance that exceeds the C.D.I.
But in the last decade, Brazil has become a rising power. Gone are the days of high inflation, and budget deficits are far lower than in most of the developed world. The country is now the world’s sixth-largest economy.
As a result, it no longer makes sense to invest with a focus on loans with a duration of a single day, but most fund managers’ mandates still require them to do just that.
Executives from Brazil’s three largest asset managers, who together hold almost half the industry’s assets in their portfolios, say they expect the government to take measures soon to prod them toward reducing the use of the C.D.I. as a benchmark.
Joaquim Levy, chief executive of Bradesco Asset Management, which has more than 276 billion reais, or $136 billion, in assets under management, said that the government was “working to create a package of incentives to encourage investors to take more market risk.”
Mr. Levy, who was Brazil’s treasury secretary from 2003 to 2006, cautioned that this prediction was merely his opinion, because no formal negotiations between the market and the government had begun yet, but “these are the signals we are hearing.”
For years, the C.D.I. provided nominal returns in the double digits and real returns in the high single digits, but with the C.D.I. at 7.11 percent as of Thursday, and inflation expected to hit 5.41 percent over the next 12 months, the C.D.I.’s yield is no longer as attractive to retail investors. It will also not be enough for pension funds to meet their obligations.
New benchmarks could accelerate movement away from floating-rate government debt into riskier investments. The industry has 2.09 trillion reais, or $1.03 trillion, in assets under management, so even a small increase in appetite for risk could cause tens of billions to move into corporate debt, longer-term and fixed-rate government debt, the local stock market and foreign investments.
Carlos André, chief investment officer of Brazil’s largest asset manager, BB DTVM, is cautious about predicting the timing, but he too is preparing for a change he calls “natural.” About 76 percent of BB DTVM’s 442 billion reais, or $218 billion, in assets under management are in funds that use the C.D.I. as benchmark.
Mr. André said this percentage, in line with the fund industry average, was already declining. “Every time interest rates drop, investors’ predisposition to assume risk grows. The C.D.I. is losing importance naturally,” he said. “I think the government is seeking to take advantage of this scenario to induce the market to accelerate the transition.”
The matter is delicate, he said, as tax or regulatory incentives, if not carefully put in place, could lead to a sudden migration from one asset class to another, throwing the market out of balance.
Mr. André said natural replacements for the C.D.I. as a benchmark for fixed-income funds are two indexes computed by the Brazilian Financial and Capital Markets Association: the IMA-B, which follows inflation-indexed debt, and the IRF-M corporate debt index. For all-asset and hedge funds, Mr. André said, many will start aiming for absolute returns or inflation plus a certain spread.
Paulo E. Corchaki, chief investment officer of Itaú Asset Management, with more than 311 billion reais, or $153 billion, in assets under management, said he expected that the transition would come in two phases: first pension funds, then the rest of the industry.
Mr. Corchaki said that about 80 percent of his firm’s funds use the C.D.I. as benchmark, but he was less concerned about how his fund managers would handle the transition to new benchmarks and more concerned with how some clients might react. “Brazilian investors are accustomed to mutual funds that have very little volatility,” he said. “If funds start to use different benchmarks and make longer-term investments, they will become more volatile. Investors will have to get used to seeing losses some months.”
Still, some say the change will eventually be embraced by investors.
“Everyone in the market is already preparing to take on more risk,” said Mr. Levy of Bradesco. “It is part of the transformation of Brazil.”