Previ, Brazil’s largest and oldest pension fund, has invested the vast majority of its BRL220 billion ($43 billion) portfolio in Brazil since it was founded for Banco de Brasil employees in 1904. That changed a couple of years ago when it shifted strategy, announcing new target allocations to overseas equity and fixed income for the first time with plans to allocate 2-3 per cent of its AUM to overseas markets by 2022 and 10 per cent within the next five years.
As Brazil’s economy reels from the pandemic and high interest rates, long prized by the large fixed income investor, edge ever lower the pressure to diversify has grown even more urgent.
That doesn’t mean Previ’s portfolio hasn’t withstood the ravages of the pandemic reassures Marcelo Otavio Wagner, who joined the fund as director of investments a year ago.
“The financial crisis has provided opportunities for entities with strong cash positions, which was exactly our case. Our concern is the slow pace of recovery for the economy after the vaccine.”
Speaking on Zoom from Brasilia, he says the fund is in a good position thanks to the bulk of its allocation lying in domestic equity and corporate bond exposures to “large and well-structured” Brazilian companies, exchange traded assets and sovereign government bonds.
Previ also benefited from opportunities on the eve of the crisis. For example, it increased its allocation to long-term domestic sovereign bonds when the Brazilian yield curve unexpectedly steepened.
“We had an opportunity to close the duration gap in our LDI portfolio. We never expected this at the beginning of 2020, but the prices got crazy. We had a good cash position and used it as an opportunity.”
Elsewhere, Previ’s 45 per cent allocation to local equity includes a value strategy that has paid off well through 2020 on the back of the steady stream of IPOs: São Paulo’s B3 exchange chalked up 28 IPOs last year, the biggest number since 2007’s all-time record of 64.
“Crises reveal the two types of institutional investor: the type that has to sell assets and the type that is able to buy, and pension funds should always be in the latter,” says Wagner.
However, the investment terrain looks increasingly challenging ahead. He is mindful of the impact on corporate revenues hit by lockdown, especially in the country’s retail sector. Brazilian utilities have also suffered a direct impact from customers not paying their bills.
“Utilities have had a direct impact on their receivables from COVID and the delinquency rate is quite high. It will pass through, but it will take quite a long time.”
The government’s response to the pandemic is another source of concern.
“As institutional investors we are concerned with how the authorities will deal with the fiscal deficit,” he says, flagging that the fiscal budget, “strained” before the crisis, is now “worse.”
Much of Previ’s investment rationale for investing so much in Brazil comes from historically high interest rates. Now his concern is that a slow recovery will keep rates low, denting returns in the 45 per cent allocation to domestic fixed income.
“Until recently we have had very high interest rates in Brazil and have had no incentive to go abroad. Dealing with low interest rates and inflation is new and requires a mindset change.”
Interest rates currently languish at record lows of 2 per cent compared to 14 per cent in 2016 while inflation is tamed at around 3 per cent.
The overseas allocations (divided between Asia, North America, and underweight Europe) will all be outsourced to Brazilian fund managers tasked with selecting assets and managing the allocations.
“We have already chosen them,” says Wagner. “13 international strategies have been approved with 11 managers.”
Previ’s internal team of 60 are responsible for the broad portfolio construction and strategic asset allocation along with screening and manager due diligence. As to whether the growth in the overseas portfolio going forward will see the pension fund mandate to global asset managers he doesn’t envisage a change.
“In this first step, we aren’t planning to use global funds.”
Previ is the big fish in Brazil’s pension sector and its first foray overseas is being closely watched by others who all share a similar home-bias.
However, it is the 117-year old pension fund’s leadership in ESG that makes it one of the region’s most influential investors. Previ is helping drive ESG integration amongst other pension funds and asset managers, providing leadership, support and milestones for others to benchmark.
“We want to help spread market best-practices in governance and risk management. We are very vocal and glad when can see the impact we have,” he says, adding that just that morning he’d been involved in a board discussion on how best to measure ESGI integration amongst the Brazilian asset management industry.
Previ integrates ESG via a rigorous risk analysis.
“Our team asks investee companies to provide us with a framework that shows us their plan to progress ESGI,” he says.
A separate risk division at the pension fund sits behind a Chinese wall from colleagues in investment, analysing all potential investments to produce a specific credit facility that takes into account all ESGI factors. And the team are prepared to increase investment in a company that scores well on ESGI.
“If a corporate bond scores well we will adjust our investment. Instead of investing, say, 10 per cent we will invest 15 per cent. That credit decision will impact the pricing and volume we invest.”
The same process in equity scrutinised the local companies recently coming to the exchange.
“We have an ESGI checklist and the company first needs to match that checklist. Only then does it go through economic and financial analysis.”
Previ has also developed the term ESG to include “integrity” – ESGI. This new seam sits behind governance and is particularly important in countries where regulatory frameworks are less robust, explains Wagner.
“It’s about stripping that I from governance and calling it something specific to help the Brazilian market to improve,” he says. “It so important to further develop our local business environment, especially taking into consideration problems related to fraud, money-laundering, and bribery that several companies have faced over the last decade.”
