Flash Note

Brazil rating downgrade September 2015

10.09.2015

Brazil has joined Russia as the second BRIC economy with a junk rating

  • S&P has finally downgraded Brazil's sovereign rating to junk (from BBB- to BB+) yesterday night
  • We have since several years highlighted the deteriorating macroeconomic fundamentals and political situation in the country and have been largely underweight Brazil in our Funds:
  • 1.5% of Carmignac Emergents*
  • 3.6% of Carmignac Portfolio Emerging Discovery*
  • Short -1.9% equities*, +2.1% bonds* and a short -5.9% BRL currency exposure in Carmignac Portfolio Emerging Patrimoine*
  • We keep our negative view and remain highly selective

*% of Assets under Management as of 03/09/2015

[Divider] [Flash Note] Rio de Janeiro

S&P has finally downgraded Brazil's sovereign rating to junk (from BBB- to BB+) yesterday night and kept the outlook at negative. The rating agency cited political issues preventing the Government from making the fiscal adjustments that are necessary for the country. Brazil had been investment grade for 7 years. Moody's and Fitch are likely to downgrade soon too.

While this surprised markets, it was something expected sooner or later and was already reflected in the sovereign spreads. The Brazil 10Y bond in local currency has been trading at an almost 15% yield since the beginning of the month. Brazil's CDS is already higher than many non-investment grade countries.

10Y Brazil yield

[Insights] 2015 09_FN_Exp_EM (Pro) 1

We have since several years highlighted the deteriorating macroeconomic fundamentals and political situation in the country and have been largely underweight Brazil in our Funds. Thus this was not a surprise to us and confirms our view. As highlighted in all our last quarterly reports, Brazil has seen fundamentals deteriorate as oil prices declined. The current account deficit (4% of GDP) has widened despite the continued weakness of the Brazilian Real. Brazil's economy is expected to shrink by 2.5% in 2015, while inflation is approaching 9%, leading to a rate increase to 13.75% in June. The recent 2016 budget proposal, which indicated a primary deficit for next year, has been the final hammer in the country's coffin (the last of a long string of negatives). Combined with the Congress' unwillingness to approve fiscal adjustment measures and conflicting views within the economic team, this led S&P to downgrade the country and keep a negative outlook. The country represents:

  • 1.5% of Carmignac Emergents*, including circa 1% in aircraft manufacturer Embraer, which, as an exporter, is a beneficiary of the weak BRL versus the USD (costs partially in BRL versus revenues in USD). The company has less than 20% of its sales coming from Brazil and an improving order book.
  • 3.6% of Carmignac Portfolio Emerging Discovery*, including a 2.3% position in the global e-commerce company Cnova N.V. (owner of the Cdiscount brand), which has almost half of its revenues outside of Brazil, in sounder regions like France, Thailand, Vietnam, Ivory Coast, etc. The remaining 1.3% is composed of Brazil's second-largest health insurer Sul America, which we believe has relatively macro independent performance drivers (improving pricing momentum, portfolio restructuration, beneficiary of higher rates...).
  • On the equity side, -1.9% of Carmignac Portfolio Emerging Patrimoine*, having hedged the stocks we own (which are the same as those of Carmignac Emergents). On the fixed income side, the Fund owns a 1.5% position* in a Brazilian public bank bond (in USD) and a small 0.6% exposure to a government bond (in BRL). In line with the Fund's spirit, combining the three performance drivers - emerging equities, bonds and currencies - this latter exposure is more than hedged by a -5.9% short exposure to the Brazilian Real, which reflects our negative macroeconomic view on the country. For Carmignac Investissement and Carmignac Patrimoine, the exposure and impact are limited as well.

*% of Assets under Management as of 03/09/2015

Brazil moving down the value chain

[Insights] 2015 09_FN_Exp_EM (Pro) 2

Of course, for equities, Brazil's poor fundamentals (lower growth, higher inflation, punitive interest rates and taxation) continues to be clearly pessimistic without a significant shift in politics, especially for domestic exposed names, and thus we keep our negative view and remain highly selective.