Is It Time to Get 'Real' With Brazilian Government Bonds?

Includes: BZF, BZL, PBR, TBH
by: Randy Durig

Brazilian Real denominated Government Bonds yielding 8.439% maturing in 2016G

Investors should consider foreign denominated debt for the following reasons:

  • Instability of US fiscal and monetary policy
  • Diversification can reduce overall portfolio risk and volatility
  • Investors seeking higher interest rates are looking abroad
  • US economy is stagnant while BRICs have rebounded
  • Globalization has added a risk/reward profile on sovereign debt

Investing in foreign bonds is not for everyone. These bonds are exchanged on global markets and the traders/market makers dictate what amounts they are willing to buy and sell. The industry norm for Brazil is 250 bonds meaning about US$150 thousand. Since many of Durig Capital's clients were asking for much smaller allotments in single foreign currency positions, we have found a way with hard work and excellent industry relationships. While working with multiple traders at different institutions, we have filled orders as small as 15 bonds or about $10,000. Owners of less than 250 bonds need to understand that this type of transaction increases liquidity risks if and or when a position were to be sold before maturity.

Brazil Overview

Brazil is the largest country in Latin America with an estimated population of 201 million people. Bordered by the Atlantic Ocean to the east, Brazil's land area drains the Amazon basin and accounts for 3.3 million square miles or 400,000 square miles, about California, less than the United States.

Brazil has the world's ninth largest gross domestic product over $2 trillion US Dollars as measured by purchasing power parity for the calendar year 2009. Brazil, as the majority of Latin America, has a history of inconsistent economic conditions over the past 200 years due in large part to extended military rule. Starting with the end of military rule in 1985, political and market liberalization efforts have given the country a new sense of prosperity. In the 21st century, Brazilians have gained international recognition as can be seen with the awarding of the 2014 FIFA World Cup Soccer and the 2016 Summer Olympics.


Brazil's economy was built on, and continues to develop, commodity-based products including oil, iron ore, gold and numerous agribusiness crops. These industries have done well in the past decade while being able to support the growth of the service and manufacturing sectors which now employ more people than the former. Economist have predicted that the Brazilian economy will continue to grow and develop into one of the top five in the world.

Over the last few years the Brazilian economy has grown steadily per gross domestic product (GDP) measurements.

Year Growth in GDP
2004 5.7%
2005 3.2%
2006 4.0%
2007 6.1%
2008 5.1%
2009 0.0%
2010* 8.8%*

*2010 Q2 Estimate

Since the end of military rule, Brazil has reduce social rule and continues to evolve toward a laissez-faire market. The government still does hold interest in private companies such as a controlling interest in Petroleo Brasileiro (NYSE:PBR) and Banco de Brasilia SA. The socialistic tendencies seem to be working along side free markets. Movements toward privatization can be seen with examples such as Telecom (NYSE:TBH). The World Bank has ranked Brazil the 129th country in the world with regard to the ease of conducting business were as the United States ranks 4th. Needless to say there is room for improvement.

Political risk encompasses Brazil's wiliness to pay interest and principal on its own issue. There are numerous factors that are included in the term willingness including style and form of government and the scope of global market integration. Below are highlights of the style and form of recent government policy and character.

Current Brazilian President, Luiz Inacio Lula Da Silva ("Lula"), was initially elected in 2002 running as the candidate for the Worker's Party. Just prior to this first election, Argentina defaulted on its debt. Economists were worried as Lula seemed to support the idea of a Brazilian default while campaigning. This could have sent ripples through the global economy still recovering from the bubble. During 2000's, other Latin American countries have electing nationalistic presidential candidates including Hugo Chaves (Venezuela), Evo Morales (Bolivia), Tabaré Vázquez (Uruguay) and Nestor and Cristina Kirchner (Argentina). Lula is seen by some as part of this sphere. International markets were skeptical of Lula initially as when it became apparent that he would win; Brazilian default swaps soared and the Rio stock market lost 5% of its value.

Since being elected, Lula has taken a more moderate political course than he was elected on although he still leads from a nationalistic viewpoint. He is responsible for shaping the political environment that exists today in Brazil. Numerous social programs have been established to raise the quality of life for the lower class including food, gas, education, transportation and water programs. In addition to general social programs, Lula has earmarked $46 billion US Dollars to infrastructure investment in poor urban communities.

The socialist programs described above have not been funded by debt alone. Since taking office and abiding by IMF monetary requirements, Lula has led Brazil to budget surpluses. He was able to repay loans made by the IMF early and, in large part due to the showcasing of fiscal responsibility demonstrated, obtained Baa3/BBB- ratings from S&P and Moody's. Since early 2008, Brazil has been a net creditor as exports and international reserves have swelled five fold since Lula took office (see graph notes below Lula Elected Jan 03).

With Lula's second term and constitutionally mandated presidency ending on January 1, 2011, elections are set for October 1, 2010. Lula's hand picked predecessor, former Energy Minister and current Chief of Staff, Dilma Rousseff is currently leading in the poles. She is running on a campaign of staying the course and keeping all of the social orientated programs Lula established funded and running. As far as one can tell, Rousseff has the same market ideology as Lula. She has served as the Chairman of the Board for Petroleo Brasileiro (PBR) since 2003.

Rate and Currency Risks

How many US Dollars one Brazilian Real can purchase since 2000
**More Dollars per Real as line moves higher**

Purchasing debt of a single currency brings on risks most have not encountered before. International Fischer Relationship ascertains that real interest rates are the same across international boundaries meaning the difference in nominal rates is based solely on inflation. Brazil has and continues to deal with inflation that is higher than the global average.

From a historical context, emerging markets in general have experienced higher inflation as a result, in part, of increasing individual prosperity. Inflation for 2010 in Brazil is forecasted to be 4.4% compared to 1.2% in the United States. The inflation differential is 3.2%, which could erode the principal. Even with inflation affecting the purchasing power of the real over the last few years, it has gained (see above) on the US Dollar since Lula's party took office and instituted new policies remembering past performance is not indicative of future.

The downturn in 2008 was due to the (see graph notes above Global Financial Crisis) that created global investor selling (creating supply) global currencies and purchasing (creating demand) what are considered safer currencies (US Dollar or Japaneses Yen i.e.).

Benchmark Dollar vs Real yields (removal of currency fluctuation risk)

Issue Yield Interest rate premium over US Treasuries Maturity Minimum Purchase Denomination
Brazil Republic 3.291% 1.16% 01/17/2017** $1000.00 US Dollars US Dollars
Brazil Republic 8.439% 6.309% 01/05/2016 250,000 Brazilian Real Brazilian Real

*We used the following treasury to benchmark the Real bonds against the Dollar denominated bonds for comparative purposes.

US Treasuries 2.13% yield 2017 maturity

**2017 trade data was the closest over the 2016 maturity as not to distort the yields with a shorter maturity
***Durig Capital has the ability to purchase either position


Placing a foreign bond into a established portfolio can assist with the diversification cause. People often think of a diverse bond portfolio as including different industries, maturities, yields, prices and ratings. These metrics do indeed diversify but overlooked are the potential benefits of holding foreign denominated debt. As recently as twenty years ago, it was hard for the individual investor to buy foreign denominated debt due to government restrictions and lack of information. We are receiving significant interest in Australian and New Zealand debt issues along with Brazil. Together he three have the potential to establish a starting point as a way to diversify into a global bond portfolio. Globalization has become entrenched in today's marketplace as information and wealth crosses boarders faster and easier. Brazilian denominated debt is on of only a few currencies the investor can choose from.


The currency and political issues could, and most likely will, affect future returns. American government debt is experiencing massive growth with little apparent control while Brazilian policies have been able to reduce their debt load. If you have followed our methodology over the weeks, it is easy to understand why we like issuers, corporate or government, with smaller amounts of debt and brighter prospects. As numerous academic studies have illustrated, diversifying ones portfolio will help reduce systematic risk. This is just another way for the investor to diversify---hold assets not denominated in US currency. While being able to reduce the overall risk, a 8.439% yield is phenomenal for a little over 5 years given the current environment. Brazil's dynamic growth, long term position as a major oil producer and their fiscal and monetary policy management gives the real a bright outlook compared to Washington's policy of weakening the US dollar in order to repay amassed US debt.

On September 17, 2010, the indication for Brazil Government bonds (250,000 Brazilian Real face value, 12.50% coupon, maturing in (2016) was at 117 (8.439% YTM) using a spot rate of 1.71410BRL/USD. These levels are continually fluid and are subject to change, but this snap shot will allows one to see how they are priced. The Brazilian Real/US Dollar FOREX rate can and will affect the returns. One just can't predict or insure that this currency will cause a positive or negative result due to the different factors that effect it.

Disclosure: Durig Capital does not but it's clients currently do have positions in Brazilian Bonds