For Hedge Fund Investors, Brazil Is the Country of Now

Ten years ago, Goldman Sachs proclaimed that Brazil was among the new economic powerhouses. Now it is the next frontier for hedge funds.

Looking to capitalize on the fast-growing region, global hedge fund managers have started to descend on Brazil. The industry’s biggest players are wooing top talent, opening new offices and buying local firms — all part of a broader effort to expand their investment reach.

“Latin America suffered because it was always believed that ‘Brazil is the man of the future and always will be,’” said Marko Dimitrijevic, founder of Everest Capital, a Florida-based emerging market hedge fund that oversees $2 billion. “But it looks like the future is now.”

Late last year, JPMorgan Chase’s Highbridge Capital purchased a majority stake in Gávea Investimentos, a top Brazilian hedge fund. Brevan Howard, one of Europe’s largest hedge funds, recently set up shop in São Paulo. This week, the first Hedge Fund Brazil Forum, an industry conference held at the Copacabana Palace Hotel in Rio de Janeiro, drew hundreds of attendees, including representatives from premier shops like Paulson & Company and SAC Capital Advisors.

In all, hedge fund assets devoted to the region rose 75 percent, to $21.4 billion, in 2010, according to data from Hedge Fund Research.
       
The strategy follows a well-worn playbook for hedge funds. Just as firms moved into Hong Kong to gain entry to the lucrative Chinese market a decade back, they are using Brazil as a beachhead for the rest of Latin America. The Hedge Fund Association planted an official industry flag on Wednesday, establishing a regional chapter with a local outpost in Brazil.

The appeal is obvious. While many developed countries have sputtered amid weak economic growth, Brazil has continued to thrive, given its rich reserve of natural resources and growing middle class. Last year, the country’s gross domestic product increased 7.5 percent — helping catapult Brazil ahead of Britain and France to become the fifth-largest economy in the world.

“In the past five years, about 34 million Brazilians entered the middle class,” said Oscar Decotelli, a partner at Vision Brazil Investments, a $2 billion alternative investment firm based in São Paulo. “This for a population of 200 million is significant. Brazil is not just a commodity story, but a very strong domestic story.”

Brazil may also benefit from a shifting emphasis in developing countries. Money has poured into China and the rest of region in recent years, prompting fears that the region is a bubble ready to burst. Asia, excluding Japan, accounts for half of hedge fund assets dedicated to emerging markets. By comparison, Latin America represents roughly 11 percent.

“People were a lot more bullish on Asian markets over the last two to three years because everything seemed to be going one way,” said Anurag Bhardwaj, head of strategic consulting at Barclays Capital, which is set to publish a survey on investor sentiment in April. “Investors are looking to other markets less correlated but with good fundamentals, and Brazil definitely falls into that category.”

Even so, the region faces headwinds. While Latin America has been relatively strong coming out of the global economic crisis, analysts are becoming increasingly concerned about inflation. The investment bank Goldman Sachs recently cut its growth forecasts for Brazil for 2011 and 2012.

Investors, too, are worried that the flood of new money piling into the market could eventually lead to diminished returns. Over the last five years, the MSCI Latin America index has gained an annualized 13 percent — the best performance of any emerging market region.

“What is the famous saying? If the taxi driver is talking about an investment, you know it’s time to sell,” said Mr. Decotelli of Vision Brazil.

But Mr. Decotelli says he thinks Brazil and the rest of the Latin America are still at the beginning of a growth story. The addition of large institutional players should help the market evolve, rather than hold it back.

“We’re still an industry very much dominated by local investors,” he said. “It is very important we are open to the international community. We will have better liquidity and diversification of strategies.”

As they explore this new territory, hedge funds are looking to well-connected executives with strong local ties. As in Asia, firms are tapping prominent names to lead their efforts, giving them much-needed political and business contacts in the country.

When Highbridge purchased a majority stake in Gávea last year for $6 billion, the deal came with the firm’s marquee founder, Arminio Fraga, the former president of the central bank of Brazil. Brevan Howard tapped Mario Mesquita, former deputy of the country’s central bank, to run its new research operations in Brazil.

A local presence serves two purposes. First, it allows for quick, on-the-ground research. That’s especially important as companies look increasingly beyond their borders for growth. In the first quarter of the year, deals aimed at Brazil amounted to $13.2 billion, a 370 percent increase over the comparable period in 2010, according to Thomson Reuters.

Second, hedge funds can better woo potential investors in the region, a newfound source of wealth. Last spring, Morgan Stanley opened a hedge fund office in São Paulo to service Latin American clients.

“Some people built too much too fast in Hong Kong, so as a general matter they are going to approach Brazil with more of a ‘Hey, let’s try this out’ rather than ‘Let’s put 16 people on the ground right away,’ ” said Daniel Hunter, a partner at the law firm Schulte Roth & Zabel. “All I can tell you is that there is definitely a desire in parts of the hedge fund space to find out what’s going on in Brazil and find out how to tap into it.”