|• Brazil’s economy is struggling and could face stagflation|
• Close presidential race adds to uncertainty
• Private bankers advocate a safety first investment strategy
• However, Brazilian clients are better educated than ever and maintain their risk profiles
• Use of credit is rising
Euromoney As we sit here in São Paulo in early August, with an election a few months away, how are clients responding to Brazil’s current, complex situation?
JW, Bradesco It is a very challenging moment for clients. Last year we discussed how clients were looking longer-term, how they were more accepting of investments with six-to-eight year terms, but, at least at Bradesco, because of the uncertainty and volatility clients are going back into short-term, liquid assets. Local interest rates are quite high, at 11%, and with so much uncertainty we really don’t know where the stock exchange will go: it could be 50,000 or it could be 70,000.
So it isn’t wrong to consider short-term, liquid assets for the time being – I don’t think you can gamble too much with the money that should pass to the next generation. I am not going to comment on politics, but if you wanted to bet that things go one way and you put more money on the stock exchange – in some specific equities – you could be rewarded pretty well next year. But with so much uncertainty it is better to be safe than sorry.
Tax-exempt products, such as agribusiness securities, offer high interest rates and liquidity and, for those banks that have access to these products, they play an important role, even though I don’t very much like this line of business: in my opinion it is not doing proper private banking allocation.
Euromoney Flavio, Luiz, are you seeing a refocussing on liquidity amongst your clients?
FS, Itaú Yes, the macroeconomic scenario is pretty challenging, as João confirmed. It is affecting us as well. First the good news: we believe that private banking clients in Brazil are today much better educated than they were in the past. We are not seeing clients rebelling against the current situation by changing their portfolios in irrational ways.
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Second, because of the unpredictability, the new money that is coming to the market has been primarily allocated into fixed income instruments, in CDI-linked tax-exempt instruments. Last year we were talking about the historically low level of real interest rates for clients in Brazil, but now it has returned to a double-digit level.
At the same time, this year the Bovespa was down almost 12%, and then it came back, appreciating, from its lowest level, by about 22% today. Clients that are not thinking in terms of long-term strategic investments, who are trying to predict this volatile situation, are probably losing money.
LS, Itaú I think this is important: at the beginning of 2013 clients were willing to take more risk because we were facing low interest rates but then 2013 was a very bad year for more sophisticated products and high-risk products.
As Flavio said, we have been working very closely with clients to teach them that their risk profile should stay the same, independent of the market conditions. They should change their portfolio because of the time of their lives, or if they have a personal life event, but not based on the external market conditions.
We talked a lot with our clients at the end of last year and none of them wanted to put any more money in the stock market. Instead, everybody was willing to put more money abroad. If you look at this decision six months later it wasn’t the best decision. So we take examples like that to teach clients and say: ‘You need to have high levels of investing discipline’.
Euromoney Is that your experience at BTG? Is the new money that is coming in staying liquid, but are clients having the discipline not to shift existing allocations in reaction to market conditions?
RP, BTG Pactual I tend to agree with what has been said so far. The new short-term money is going to tax-exempt bonds like never before and a few banks offer huge amounts of these instruments. I also agree that I haven’t seen a lot of movement, or any type of panicked reallocation that I would probably have seen in other economic or political cycles.
I also agree that last year wasn’t a very good year in terms of returns for hedge funds, multi-market hedge funds in Brazil, or equity funds, although there were a number of success stories as well. Still, clients learnt to pick the right instruments, or the right vehicles within their asset classes, and have maintained their strategies and not swapped asset classes if short-term results haven’t been good.
Last year we also had a tremendous amount of clients wanting to invest offshore, first through local vehicles and local funds, and then following that by sending money abroad and going cross-border and establishing or increasing offshore accounts.
Finally, with the economic uncertainties of the past six-to-eight months, and also with the possibility of a very tight election – which if it goes to a second round might be a toss-up – I think a lot of people are on the sidelines waiting to see exactly what is going to happen.
MS, Santander You have a consensus here on the economics, so let’s just state the numbers. We see GDP close to 1% or even less, inflation at the top of the target and a Selic rate of 11%. We expect next year will be very similar.
In terms of portfolios, we are working with a ‘neutral portfolio’, which means we recommend a neutral position in the principal asset classes, with a strong allocation to our asset model depending, of course, on an investors’ individual risk profile.
Euromoney Within fixed income the trend for money is tax-free products. João, you said you don’t particularly like tax-free bonds. Is that because the public banks have a stranglehold on supply?
JW, Bradesco I said I don’t like them because they defeat the purpose of advisory. It is so simple just to invest in these – you don’t need private banking, you don’t need advisory. My son is 17 years old, he can probably make that allocation. With all due respect, this is not a job for private banking.
However, in the short term it is a great product – it is liquid and the return is really aggressive. But it defeats the purpose of real asset allocation in a long-term portfolio. There is no strategy – it is like a money market fund paying more than CDI. It defeats the purpose, thereby destroying the business and destroying the industry. There is no challenge, no advice, nothing. Private bankers like to see medium- and long-term investments invested well for the next generation.
The turnaround point, where things changed, was a couple of years ago when the interest rate in Brazil reached one digit, as low as 7.25%. That moment was crucial because clients said: ‘These days of CDI and liquid assets, high interest rates and low risk are over’. At that point the client started to sit with us and discuss medium- and long-term portfolios. It was a very good time to re-educate, both ourselves the bankers, and then the clients. Bankers are now much more mature and clients are much more educated.
|Presidential race: Opposition candidate Marina Silva faces off against president Dilma Rousseff|
Euromoney Those clients that are keeping liquid and short term, what do people think will be the trigger points for their re-entry into longer term investments?
FS, Itaú It is not very likely that we are going to see a big change prior to the election. Regardless of Brazil’s political future, it is clear that the local interest rate will be kept at a high level, so it doesn’t matter if we are talking about candidate A or B, we are going to see the CDI kept at around 11%.
We are going back to a situation where Brazil is very different from other large financial centres in the world, in that clients can basically have a very decent return with daily liquidity and very low volatility. If this is going to be the name of the game, then we need to adapt and clients are adapting to this. In my view, it is our job to continue to have a very disciplined and strategic discussion with our clients about their long-term objectives for their portfolio.
Let me give you an example: just the other day we were talking with a client who had sold his company for R$200 million. He was telling us that he was going to allocate 100% to a tax-exempt product. The question for him, a 68 year old man, is: ‘Do you believe that you need to manage your entire portfolio – the money that you are going to need for the rest of your life – in the same way that you are going to manage the money that you want to provide for the future generations? Do you think that you need the same portfolio for the different objectives?’ This is the type of discussion we are trying to have with our clients and we have an opportunity to have a more elaborate discussion with them.
MS, Santander We need to educate our clients but first we need to educate our bankers. In practical terms there is no big premium to take risk in Brazil, at least at this moment. We believe in asset allocation, we believe in diversification – and we show clients this – but it is not easy.
Additionally, there are other kinds of investments to consider. For example, in Brazil we are focusing on structured debt instruments such as infrastructure debentures that add value to portfolios and are also tax-efficient, and it is a very interesting product. Infrastructure projects are considered a long-term investment and, with trading activity increasing, also offer investors some liquidity, so this is a new market and we as an industry can explore it better than we are doing.
RP, BTG Pactual I agree with the criticism of tax-exempt bonds, and I completely agree with João that it is hard to have a client asking for 1% plus the CDI rather than a fruitful discussion regarding his portfolio allocation and long-term needs. But this is part of a cycle; it is a long cycle, but it will eventually come to an end.
And this cycle provides a couple of opportunities. For instance, last year the industry didn’t grow much in terms of AUM. The official numbers are close to 10% [AUM growth], but that didn’t really represent a growth of assets, but rather some reclassification of clients’ funds by some of the banks.
For BTG Pactual, last year was probably the worst year in terms of AUM growth, at below 10%, but our revenues increased 40%. In the last four years we have been growing AUM at around 20%-25%, but our CAGR for revenues is over 40%. I think it is because clients are parking liquidity with a couple of banks and in a couple of tax-exempt products but they come to us for compelling advice, with a different, long-term view, including an important international focus.
So we have gained market share within those more strategic allocations, including international diversification. It is now a different game for a couple of banks and it is definitely a different game for us. Whenever the cycle ends, clients will eventually be loyal to those banks that have the capability and the sophistication to provide them with good, long-term, multi-class, global advice.
Euromoney So there is a bifurcation in the market between providers of tax-exempt fixed income ‘commodities’ and long term private banking?
RP, BTG Pactual Yes, and it is a long-term process. Like Flavio said, we have moved from a time when interest rates in Brazil were very high, to when they were around 7%, and then they came back up. I think they will stay up for a while, that is a fact, and tax-exempt bonds will be here for a while. However, the whole idea behind those instruments was to provide cheaper funding for the real estate and agriculture industries. Of course, part of the benefit went to the investor.
Nowadays, it has come to the point that almost 100% of the benefit is on the investors’ side. This market will eventually come to an end. We just have to be there every day and keep giving good advice to clients.
LS, Itaú We faced a situation like this in 2008 when banks were paying higher rates to keep their clients’ money in the CDI, but the difference was at that time it wasn’t daily liquidity. What we are facing right now is a challenge; because it is good to invest part of your portfolio with 90% tax-exempt CDI with daily liquidity.
And of course, it is hard to say to the client: ‘No, don’t invest. You should invest between 20%-40% in this, but it is not good to have 100% just in one product, just in one risk of credit’.
What we see is the big client, the $1 billion or the $100 million client, has more power and can invest in many banks – he/she can go to BTG and to Itaú as well as to the public banks. But we still have the space to work with clients with R$10 million to R$5 million because they can’t put all their money, or a big part of their money, in a public bank because they value our advice. We are facing a bigger challenge with the ultra-high net worth clients than with the high net worth clients.
We are also facing the same situation as BTG. Last year we grew around the market average. If we take out the tax-exempt products then we gained a lot of market share, it was probably our best year. When we talk about revenues, we were in a situation very similar to BTG, because in the past – three to four years ago – CDI-linked products represented almost half of our business. If we look now, it represents less than 20% we believe we are well prepared to receive this money back when this cycle ends.
Just to make a prediction, I believe we are very close to the end [of the tax-exempt products cycle] because everybody here agrees that next year we will have a fiscal issue in Brazil. If we look to the size of these products, right now we are talking about a market of between R$300 billion and R$400 billion and so are talking about the government giving away taxes of between R$4 billion and R$5 billion annually.
Whoever forms the new government will look at this and say: ‘It doesn’t make any sense’. However, CRIs, CRAs or the infrastructure debentures make sense because we are talking about long-term investments, which was originally the whole idea of tax-free investing.
VO, Santander With high interest rates, like we have in 2014, these types of products have a lot of impact but this strategy will probably be closed in 2015 or 2016. The government has to make some fiscal adjustments and we believe the clients are waiting until after the elections to see what kind of adjustments the government will do before they decide into which type of investments, or which type of products, to allocate money. I believe we are going to see this cycle ending by the middle of next year.
Credit as a new business
Euromoney Are there any new opportunities for the private banks while you wait for this cycle to end??
JW, Bradesco The higher the interest rate, the tougher our job as advisors is because clients eventually will move away from equities and to traditional instruments. We have seen this recently, and perhaps this is the time to reinvent the business and add more advisors.
For example, a lot of private bankers are starting to provide credit lines. This is a very profitable business. This is the business that, at least at Bradesco Private Bank, has grown the most in the last few years, and especially this year. I am being compensated for the revenues that I lose by granting clients credit line facilities. It’s a good business, clients can leverage their portfolios, they can grow assets, and this has happened because we had to reinvent our business.
GP, BTG Pactual I agree. On the advisory side, credit is playing a very important part on the growth/revenue side. It is an instrument that has helped keep a lot of clients with the bank for the longer term.
Sometimes it is not just about the credit interest rate, it is about offering the right credit structure, the one that makes a difference, and we have been able to grow credit services. We are investing in that unit and it has been interesting to see that without capital markets activity clients do need credit sometimes to unlock a little bit of liquidity.
RP, BTG Pactual Relative to total revenues we have increased credit’s participation five-fold.
Euromoney That’s interesting because you would think with rising nominal rates and a focus on liquidity that it is not a particularly good environment for launching credit services?
GP, BTG Pactual Yes, but at the same time there are a few very nice opportunities. There are certain asset classes that are a little bit depressed in terms of value, so clients are using such a challenging environment in the economy to consolidate. As we have a very close relationship with the investment banking guys, sometimes we do use credit on our side to help a client buy a competitor, or to unlock a little bit of liquidity for the families. It makes a difference if you have a more global approach in terms of taking care of the operational assets, be it the company that the client has, the real estate and the liquid assets. Credit is, let’s say, the oil of this engine sometimes.
JW, Bradesco We will not allow our client to cash-out money to buy, for example, a new home. Let’s say R$3 million would be a normal real estate transaction for a client and so we offer 30 years’ financing that he can pay in monthly instalments out of regular, monthly income without touching his investments. It works so well. I would say 80% of the clients we approach with this proposal accept.
Euromoney Really? Because it is presumably a relatively new mindset for a lot of these private wealth clients?
FS, Itaú We have also seen credit growing in the last few years. In the last year, credit in the real estate part of the business remained steady despite the fact that the interest rate is higher than it was, but still attractive. Our credit portfolio is growing at a faster rate than overall AUM, but the higher interest rate has slowed down its growth a bit. We continue to see some specific opportunities in which clients use their local portfolios as collateral to leverage and build international portfolios. But credit, as a whole in Brazil, still has a long way to go to have the same level of importance it has in other markets, especially if compared with the US.
VO, Santander Clients used to have a mindset that credit wasn’t good. They would say: ‘I have money, so I should use my own money and not take credit from the bank’, but credit is part of the wealth planning. Clients don’t need to use their own money if it is invested in long-term assets, and then credit becomes an opportunity.
We are teaching our bankers to have this kind of conversation with our customers and we have been growing credit by more than 50% a year for the last three years, and we are still far away from optimizing the opportunity that we see. If we talk about mature markets like Europe, or even Spain in our case, our private banks there have 25% of their AUM in credit. If we talk about the industry here in Brazil we have 3%. There is a lot of room to grow credit, not only through mortgages or agribusiness loans in our case, but also through structured operations.
And just a comment on services: I believe that with this pressure on fees, commissions will play a large role in our revenues next year. Having a full service for your client, in which we can offer not only the investment part but also credit, credit cards, insurance and things like this, is going generate a huge part of our revenues.
JW, Bradesco Also, the non-performing loan ratio is very low, it’s close to zero because you keep the investment as collateral, and in our case the ROA is four times bigger than average return on the traditional business.
Euromoney Inflation is at the top of its band and is still being artificially managed. Are clients getting concerned about inflation in the short term? Is there a search for inflation protection, through inflation-linked bonds or other assets?
LS, Itaú We like to have those products invested in the clients’ portfolios, but what is more important for the clients to understand is that if they want to invest in inflation-linked bonds or other instruments – such as higher duration bonds, hedge funds and even equity – they need to have to look at investment horizons of at least 36 months.
When we look through this perspective, even during atypical markets like we have had the last two to three years, clients got good results. If a client wants to invest in equities because he or she has a view on the election, we say that it is better to go to the casino. It is important for clients to understand that it is good to have these products in the portfolio but to be prepared for higher volatility. That is the only guarantee that you can give: you need to be cool in bad moments.
RP, BTG Pactual As was mentioned earlier, the Bovespa could, hypothetically, go over 70,000 or go back to 45,000 after the election. But if we are talking about developing clients’ portfolios in terms of long-term ambition, then investing is less a question of speculation about who will win the election – or even about where the Bovespa will be in February or March next year – and much more of a long-term approach, in picking the right managers that will look into companies that will perform well, will have sound execution, regardless of the economic cycle or the political cycle.
It is more important to take a view on the corporate governance of any company, or its strategy and management or how it will deliver results.
GP, BTG Pactual In terms of inflation protection the name of the game is diversification. If you look at the local industry there are very few instruments into which you can diversify. Take the hedge fund industry in Brazil: although you allocate to many funds, the vast majority of the industry has a very high correlation to a scenario that worked really well in 2013 and then suddenly stopped in 2014. Basically the industry was long dollars and that trade – I wouldn’t say that it went away – but it corrected a little bit.
The clients that diversified offshore internationally in 2014, even through local instruments, fared a little better than the others. Within BTG we have been pursuing that strategy since 2009. Our flagship fund, BTG Global, has two-thirds of its risk managed abroad.
Clients need to understand that they already carry a lot of Brazilian risk in their portfolios, within their company and real estate. So it makes sense to have more diversification in the liquid assets, either wrapped up into a local fund or by sending the money abroad and opening accounts outside the country.
Diversification is critical – perhaps the local scenario is playing an important role in market volatility but the most important economic variable is still the US Treasury. That is key, and we are all trying to guess out what is going to happen.
Given current prices, what we are seeing, or at least we are trying to advise our clients, is to lower the risk profile a little bit, to be on the sidelines with short duration, fixed-income assets and wait to see what will happen and what is going to happen to the US Treasury.
We are in a very strange scenario in which markets are going up and volatility has gone down, so it is very challenging in terms of putting money to work. We prefer to deliver less compelling returns, but be more on the safe side, be it locally or abroad.
FS, Itaú Offshore diversification is a very important topic. We continue to see our clients diversifying – maybe not quite at the same levels of 2013 – despite the fact that today we have a weaker real and higher interest rates locally. Obviously, in a moment like this, long-term strategies are not as in demand as they were last year. However, there are still many reasons for a client to invest offshore where he is going to have access to the whole alternative of asset classes and products.
Euromoney Guilherme, is BTG leading by example with your acquisition in Switzerland? Is it a good time to buy foreign assets?
GP, BTG Pactual The strategy behind the acquisition of BSI [a Swiss-based private bank] reflects the fact that the international private banking market is also in a challenging moment. If you take the developed markets, and how regulators are treating both banks and clients, it is a very tough environment. Banks are moving away from certain markets to others, but if you look at the industry itself it is still very healthy. Private clients need a very good service and they are happy to pay a few basis points for that.
In such an environment, in which clients are seeking service more than secrecy, we think we can play an important role. BTG Pactual has capital: the bank has motivated people and has the culture that, at the end of the day, makes a lot of a difference to our clients. Our clients love to hear what we have to say and where we invest our own money. If that is true for Latin America, it is also true for a broader client base. Scale is very important, but you have to combine that with advice.
In terms of international portfolios, we have seen a tremendous growth into managed accounts, with very large clients looking for tailor-made products that don’t just establish a strategic asset allocation, but that manage that allocation through rough waters.
And now is as rough as it gets. You have risks everywhere, take Ukraine, take the US Treasury, perhaps China could be a very important risk down the road. Clients love to feel that they are very close to the action. They want access to the best-in-class products and over the last four years we have been investing a lot in getting people that can bring this advice to the table. We are happy with the results: advisory is the name of the game and, at the end of the day, they are happy to pay a few basis points for that.
Euromoney Marcos, at Santander you have that natural global breadth, is that playing well?
MS, Santander Brazilians want access to offshore investments. We have international links, we have a strong presence in different countries and we are able to provide technology that links local markets with a global services model, tailored to the local characteristics.
We offer a full range of investment opportunities and we offer investment management for three different models – we have a discretionary portfolio, an advisory portfolio and we have a proprietary unit offering clients a broad range of products and services, with innovative ideas blended with agility and flexibility.
We also have an international real estate advisory service, which means an advisor executing commercial real estate transactions in the USA, and linking the US and European markets to optimise the diversification of our clients’ assets. We are increasing our international AUM from Brazilian clients by the month, as clients increasingly seek diversification into international markets.
VO, Santander Clients are not only looking for investment funds abroad, but over the last year they have also been seeking to invest in the real economy in Europe or in the US. With our presence in Europe they are looking to us as these economies start to grow again for investments in Spain or even in Italy or the UK and we have seen cases, for example, of clients buying shopping malls or properties.
Euromoney What about for Bradesco and Itaú? Are you focusing on the local market or are you looking for acquisitions like BTG? What is your strategy and how do you think you can match this search for international diversification with all these clients?
FS, Itaú We started to expand our international operation about seven years ago when we bought two operations in the US to add to the operation that we had already in Luxembourg. More recently we decided to concentrate our European operations in Switzerland, so we opened a bank in Switzerland in 2010. It became fully operational in 2012 and we have consolidated all the assets that we had in Luxembourg in Switzerland.
We have been investing heavily in offshore investments since then, with a strategy that is fully in line with the bank’s global strategy, which is to become a global Latin American bank.
Our ambition is to be a leading player in Latin America, helping our clients that want to do business abroad. For private bank clients who want to invest abroad, we offer them access to any market in the world and the other way around – for international companies that want to come to Latin America, Itaú should be the first name in their minds as a gateway to the region.
In line with that strategy we have been investing strongly in the region. In 2011 we did a 50% acquisition of MCC, a leading independent wealth manager in Chile, and we just increased our participation to 100% and we continue to look for opportunities like this in the region.
Itaú announced earlier this year a very important transaction with Corpbanca in Chile and Colombia. Our investment bank division, Itaú BBA, is investing to build local presence in Peru and Mexico. This will support our private bank strategy to grow in the Hispanic markets in Latin America.
Since 2009/10 we have been very proactive with clients to encourage them to adopt a global mindset. We believe that a global approach to the portfolio of the client is mandatory today.
JW, Bradesco In the past, the average Brazilian client would, as was said here by most of us, send money abroad for the wrong reasons. They would send money abroad during economic or political turmoil.
For me, global diversification is part of the education process and you cannot today be a large, important player if you don’t have domestic and offshore business to offer. This is definitely a growing business. Most banks this year will make more money on their international business than their local business.
You simply need to be able to offer international assets and advice, just like today you don’t even discuss whether your technology has open architecture. Ten years ago that technology was a differentiator but now you have to have it or you will be out of business. Now it’s the same with having a global presence. At Bradesco we are not doing any acquisitions, but we have our private bank in New York, the Cayman Islands and a bank in Europe, based in Luxemburg. We serve our clients out of those units. It is a growing business, mainly for ultra-high net worth individuals who definitely want to have part of their investments abroad; be it 5% or 50%.
When these clients ask for global advice the key thing isn’t the short-term return from interest rates in Europe or US, which are close to zero, while in Brazil it is 11%. The thing to consider is the long-term strategy that requires that part of a client’s wealth should be in other global currencies. This is a very basic part of the diversification.
GP, BTG Pactual If you are not a Brazilian you wouldn’t have 100% of your money invested in Brazil, given the challenging environment you are seeing. Brazilian clients who went through liquidity events through an M&A or an IPO probably need to think a little bit more like that.
Diversification is critical and you need to be able to send a message that you have this capability. We have always considered ourselves a global firm, but with the BSI acquisition we are even more established globally. We feel we are very well positioned to exploit diversification
MS, Santander One of the most important things that differentiates Santander internationally is that during the past year we have strengthened our relationship with our clients in Brazil by showing them the benefits of investing abroad.
We centralize the relationship and with our presence in so many other countries, we believe that we bring a different overview to our clients than the local banks, because our international network brings some very important opportunities, specifically in the real economy or in the real estate market.
Euromoney What kind of international assets are attractive to Brazilian private bank clients?
JW, Bradesco Previously a Brazilian would send money abroad and buy Brazilian hard currency bonds. It is our job to tell them they are repeating the risk, just with a different currency, and I think we are doing a good job in improving asset allocation during diversification. There are so many opportunities and different lines of business that you can offer globally than locally, so why just stick to fixed income Brazilian bonds?
I would also say that clients are themselves becoming more global than ever before. They are travelling more; they are buying real estate in Florida and New York, and so naturally they are starting to look for global advice.
RP, BTG Pactual I agree – it used to be the case that private banking clients would send money abroad to buy Brazilian bonds, cash, a few equities and perhaps some hedge funds, which somehow got lost in the 2008 crisis.
We made a huge effort in doing asset allocation in a number of other asset classes, and in the last three years we have raised over $1 billion. This year the returns on diversified portfolios are very good. The acquisition of BSI opens more doors in Europe and Asia, where BSI has 300 people alone, which opens new possibilities for clients. In the long term, as we have been saying, the growing sophistication of Brazilian clients is here to stay.
It hasn’t really gone away even if this cycle of increasing interest rates – and the great offer of tax-exempt bonds – makes it look like it has. But the work that everybody around this table has done internationally in the last four years has forever changed the face of the market.