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Investors seduced by Latin moves

With its president taking the right steps and commodities running hot, Brazil is pulling in capital, THERESA EBDEN reports

Like the seductive rhythm of the samba, the Brazilian stock market's quickening pulse is luring foreign investors.

Among the international buyers is Patricia Perez-Coutts, a vice-president and portfolio manager at AGF Funds Inc.

Since taking over the $130.1-million AGF Emerging Markets Fund in 2002, Ms. Perez-Coutts has increased its exposure to Brazil after correctly betting that leftist President Luiz Inácio Lula da Silva wouldn't be so "suicidal" as to call off the country's debts -- even though he had vowed to do so in his previous three runs at the presidency.

The AGF fund's current exposure to Brazil sits at about 18.5 per cent.

"The investing environment has been improving over time," Ms. Perez-Coutts said. "It's not a perfect country, there are sources of inefficiencies. But it certainly is a sea change from three years ago. It certainly evolved, from a left-leaning political party that was in danger of abandoning commitments to a darling."

The economic statistics are compelling. The benchmark interest rate has declined to 17.25 per cent after a 0.75-percentage-point reduction last month, from as high as 26.5 per cent in 2001.

Considering the Brazilian real's 71-per-cent appreciation since Lula's election, as well as earnings growth that has averaged 20 to 25 per cent annually for the past three years, Ms. Perez-Coutts says she's still very much attracted to the country's stocks. The benchmark Bovespa Index has risen 59 per cent in the past year.

Brazil hasn't always looked this good, however.

"In 2003, equity markets and bond market valuations suggested the country was on the precipice of bankruptcy," recalls Brent Bottamini, an analyst and portfolio manager who helps oversee the Fidelity Latin America Fund with Adam Kutas. "President Lula had just been elected; his election run took a very leftist and populist front. Rates went through the roof, and the currency backed up."

Like Ms. Perez-Coutts, Mr. Bottamini was ready to buy.

With the government cutting its target lending rate to stimulate growth, and the currency strengthening, his bets have paid off.

"Clearly the administration has had an impact on the country. Clearly you're seeing Brazil emerge and mature," he said.

Even when President Lula was mired in a corruption scandal involving his ruling Workers' Party last summer, Brazilian bond yields were "relatively stable," indicating that investors weren't giving up on Brazilian holdings, Mr. Kutas adds. The move by Brazil's central bank in December to repay ahead of schedule some $15.5-billion owed the International Monetary Fund only strengthened investor resolve. Not only did the country's move save nearly $1-billion in interest but it left Brazil debt-free with the IMF for the first time since at least 1984.

"Nobody expected that Lula would have these policies," said Mark Mobius, who oversees $22-billion (U.S.) in emerging-market stocks at Templeton Asset Management Ltd. Today, Brazil provides the biggest geographic weighting in Mr. Mobius' Templeton BRIC Corporate Class Fund, which focuses on investing in the emerging markets of Brazil, Russia, India and China.

Since Brazil's debt scare, investors such as Mr. Mobius have leapt into the nation after evaluating market indicators. In particular, he notes the narrowing difference between the yield demanded by Brazil's lenders and the yield paid by U.S. Treasuries. "When you get that kind of decline in spreads, it's a very clear sign of confidence in the country, and that of course has come about as a result of Lula coming in and having conservative fiscal policy," Mr. Mobius says.

But the president can't take all of the credit, he adds. The global commodity boom has also helped Brazil, which is a major producer of raw goods such as iron ore and sugar.

The top two holdings in Mr. Mobius's BRIC fund are Petroleo Brasileiro SA, the state-controlled oil company known as Petrobras, and Companhia Vale do Rio Doce, the largest iron ore exporter in the world, often referred to as CVRD. Together they accounted for more than 14 per cent of the fund as of Dec. 31.

The banking sector also is powerful in Brazil, and in his top 10 holdings for the fund, Mr. Mobius counts Banco Bradesco SA.

As interest rates fall in Brazil, equity investors are also focusing on the consumer segment, as there is a fair amount of reliance on credit for purchases, said Mr. Kutas at Fidelity. His fund's big holdings include banks with strong consumer businesses such as Bradesco and Banco Itau, in addition to the country's large commodity companies such as CVRD and Petrobras.

Even with the rising investor interest, Brazil's economy is a long way from that of Chile, which is widely acknowledged as the most stable in Latin America. But many investors are now saying that Brazil may be more attractive than Mexico, even without close proximity to the trading powerhouse of the United States.

Even so, investors buying into Brazil are aware that the party seen in the equity markets isn't as sure a bet as the annual Carnaval festivities.

"Brazil really ought to be growing a lot faster than it is, like something in the order of 7 per cent annually," said Ken Rogoff, an economics professor at Harvard University. The country didn't reduce its interest rates quickly enough to encourage growth, he added.

"They have the highest real interest rates in the world. The only country in the world which was close to them was the Dominican Republic, which is not exactly good company to be in," said Mr. Rogoff, who served as economic counsellor and director of the research department of the International Monetary Fund from August, 2001, to September, 2003. "At this point, the balance has tipped to where they need to worry more about growth and less about inflation."

Another problem in Brazil, which even today remains the largest debtor among developing nations, is its huge government, he added. As well, its high tariffs deter global manufacturers from shipping goods to be processed in Brazil and then exported for the next production step, he said.

President Lula said earlier this week he expects a strong economic rebound this year. GDP growth is expected by some analysts to have slowed by more than half last year from the 4.9-per-cent pace seen in 2004.

Meanwhile, Mr. Mobius' best line of defence is to buy companies that can withstand setbacks. The biggest risks to the region include a rapid decline in commodity prices or the election of a government that denounces free and open markets and globalization, he says, and neither are particularly likely.

"Despite the good news and euphoria, Brazil has an unhappy knack for surprising people," Mr. Mobius said. "So we always have one foot out the door in the event that political conditions change."

Theresa Ebden is an associate producer for Report on Business TV.

© 2007 The Globe and Mail. All rights reserved.

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