From the July 2012 issue of Investment Advisor • Subscribe!

Rise of Brazil and the Beautiful Games

For Brazil, the 2014 World Cup and the 2016 Olympics are about more than just sports—they’re a chance to showcase that the country is worth investing in

Illustration by Robert Carter Illustration by Robert Carter

Think Brazil, think soccer, then think the 2014 FIFA World Cup. Could the stars possibly be more perfectly aligned?

For a nation whose lifeblood is soccer, that was nascido para jogar (born to play) and is one of the fastest growing economies today, probably not. Add to that the 2016 Olympic Games, to which Brazil is playing host and which will, like the World Cup, greatly increase Brazil’s standing in the international community, and there’s little doubt that Brazil is on course to a far sweeter spot than the one it’s in now. Pulling off both events with aplomb will lock in the country’s many fans, international investors included, for the long haul.

Already, foreign investors have been greatly attracted by the country, which has made spectacular progress in its journey from emerging market to BRIC nation: a country where a strong fiscal picture bolstered by the right kind of political leadership—one that is apparently resolute in its commitment to lasting reform—has resulted in a solid foundation for Brazil.

Today, says Alex Ashby, a research analyst at Global X Funds in New York, Brazil can be proud of its impressive achievements, which include successfully lifting millions of people out of poverty, sustaining an extremely low unemployment rate, maintaining public debt at low levels and ensuring an open and encouraging environment for foreign investment.

Natural resource-rich Brazil has benefited immensely from the global demand for its commodities, particularly from China, but the Brazilian administration hasn’t taken things for granted. Apparently focusing on longer-term strength, the government has stuck to its reform agenda, looking to encourage privatization in different sectors of the economy, tackling important issues like corruption head on and seeking to overhaul both the public and private pension systems. Brazil’s central bank has also proved to be a real pillar for the economy and adept at keeping the exchange rate stable.

“Obviously, the growth that Brazil has experienced in recent years has changed things more or less permanently,” Ashby says.

But, he cautions, the situation can also go the other way very quickly if Brazil is not careful, which means that the country cannot digress from its chosen agenda.

Brazil has shown no sign of going down the route Argentina recently took with respect to increasing public sector involvement in the economy (in March, the Argentine government announced its decision to take a large stake in YPF, the country’s largest oil company), and it probably won’t. The country has nevertheless made significant gains that it cannot afford to lose; not just with respect to the importance of the events in 2014 and 2016, but to ensure its future as a key player in the global economy.

“Now more than ever, Brazil cannot regress, as investors want to see the kinds of reforms that would move the country forward rather than back,” Ashby says.

These include easing the cumbersome tax burdens on certain industries and promoting pro-growth policies to help Brazilian industry compete globally, he says. The government has successfully raised interest rates to combat the threat of inflation, but this has made it tougher for Brazilian companies to borrow at low rates, which is why growth has slowed.

Ensuring that foreign investors remain interested in Brazil is key. Overall, Brazil is a much easier market to invest in than its fellow BRICs, says Ryan Issakainen, an ETF strategist at First Trust Advisors in Syracuse, N.Y., who follows Brazil closely. Still, the tax rates for foreign investment are relatively high.

“Brazil sees the value of bringing foreign investment into the country, and definitely there are less regulatory burdens in Brazil than there are in, say, India, but some of the policies in place are less friendly toward foreign investment, and it would be good to see some of that revised,” Issakainen (left) says.

But for investors like Issakainen, Brazil’s greatest problem, and one that it needs to tackle properly without further delay, is its infrastructure. That should be the highest priority on Brazil’s “to do” list. Policy reform is necessary in the short term to encourage the speedy build-up of lasting infrastructure, but it’s also the platform from which Brazil can go to the next level and ensure continued growth in the long term.

Infrastructure Is a Challenge

Consider that the United States is ranked fifth in terms of global competitiveness, while Brazil is ranked 53rd. Brazil is younger and it’s growing faster, and yet, says Aaron Visse, a portfolio manager at Forward Management, it ranks far behind the United States when it comes to infrastructure.

“Brazil has been in a declining trend of investing in infrastructure compared to other BRICs, but a lack of infrastructure and the bottlenecks [it] creates are pretty big impediments to long-term growth,” Visse says.

It’s been said time and time again that all emerging market countries, the BRICs in particular, have serious infrastructure needs. In the case of Brazil, though, the need is even more pressing, Visse says; not only because the country badly needs roads, highways, train lines and ports to accommodate the onslaught that the 2014 World Cup will bring, but because for whatever reason, the government has never committed in a meaningful manner to developing infrastructure.

Aaron Visse“China’s transformation has been largely a function of its unwavering commitment to building world-class infrastructure. Even though China also faces bottlenecks, they are more than willing to invest in that area,” Visse (right) says. “Brazil has not focused as much on infrastructure as it should have, but not addressing infrastructure will eventually hold back its potential for long-term growth.”

Brazil’s alleged lack of focus on proper infrastructure development has been a thorny issue in the run-up to the 2014 World Cup. Many—most importantly the head of FIFA, the international soccer governing body—have contended that nothing is being done to alleviate existing infrastructure bottlenecks and to ensure that all the requisite new facilities are in place before the big event. The Brazilian authorities have, of course, countered the allegations, but it goes without saying that the events of 2014 and 2016 serve up the perfect excuse to address Brazil’s infrastructure needs for the long haul, Visse says. By encouraging and enabling proper infrastructure development through policy and planning, Brazilian politicians can help provide a platform for long-term economic growth.

“Brazil has to make infrastructure a larger percentage of its GDP because if a country underinvests in infrastructure, it’s capping its long-term growth potential,” Visse says.

Brazil has recently proposed a $17 billion commitment to building up mass transit in some of the major cities that will be hosting the World Cup matches. Sticking with the plan and seeing it to its fruition will only be to the country’s benefit in the long term, Ashby says, not only because they will greatly enhance day-to-day life in Brazil long after the World Cup is over, but also because these are the sorts of moves that will make foreign investors keen to invest in Brazil.

“Obviously, some of the infrastructure challenges that Brazil faces are going to be difficult to implement fully to get to the point where they’re functioning at highest capacity in 2014 or even in 2016,” Ashby says. “But these two events are a catalyst for Brazil to invest in infrastructure, and getting more private sector involvement in infrastructure financing should be a major goal for the government.”

Infrastructure Is an Opportunity

As much as Brazil’s infrastructure lacuna has been frustrating, it also spells a vast potential to come.

In fact, Forward’s Visse, who runs a global infrastructure fund (KGIYX), has a significant overweight toward Brazil, and is particularly enthusiastic about the prospects for transport infrastructure. Several international players have given their vote of confidence to the sector, namely Spain’s Abertis, which in late April took up a 60% stake in Brazil’s Obrascon Huarte Lain (OHL), a publicly owned and traded highway concessionaire.

Other companies such as EcoRodovias (the third largest holder of highway concessions in Brazil) and Companhia de Concessões Rodoviárias (CCR), one of the largest private infrastructure groups in the world, will be evaluating new opportunities for projects as they come up, Visse says, which is why “we think both of these companies will be the beneficiaries of long-term growth in Brazil.”

Although Visse doesn’t have the same enthusiasm for utilities on a global basis, he is certainly enthusiastic about them in Brazil, and again, he is overweight the sector compared to the index.

“One thing you benefit from right away when you invest in Brazilian utilities is the fact that Brazil has the world’s largest source of renewable water, so most of their generation is hydro,” he says. “You get away from any sort of climate legislation that may be forthcoming, you don’t have a lot of nuclear, and what you’re exposed to is a lot of very clean and renewable energy generation. The Brazilian utilities are also operating under a pretty clear regulatory environment. They are good inflation hedges in a market where there’s greater inflation, and they have a lot of growth potential.”

Not to mention that Brazilian utilities are trading at much lower multiples than their U.S. counterparts.

An Economy Big Enough to Slice

Brazil’s infrastructure potential is just one piece of the opportunity pie that will allow investors to get to the meat and potatoes of economic growth. Investing at the micro level in sectors like infrastructure and in companies is the best way to capture the opportunity that long-term growth presents at the local level.

For Nick Cowley, portfolio manager at Henderson Global Investors in London, Brazil is an important play. It makes up 15% of Henderson’s Emerging Markets Opportunities Fund (HEMIX). Cowley—who manages the Latin American sleeve of that fund—focuses on interesting stock opportunities in Brazil that offer a secular growth opportunity no matter what’s happening in the global economy by improving the penetration of a product or service in the local Brazilian economy that can really capture the upside of local economic growth.

One of the biggest holdings he has is BR Malls, a shopping mall operator.

Nick Cowley“In Brazil, only 20% of total retail space is in a mall environment, compared to 50% in the [United States] or Mexico,” Cowley (left) says. “Clearly, [there are] a great deal of opportunities for new shopping malls in Brazil, and for investors, a good way to benefit from the rising middle-class story.”

That’s a story that, Issakainen says, is still not that easy to get access to for foreign investors.

“Most of the indices that track Brazil are still relatively top heavy, which means they mainly feature the large Brazilian companies, those that are multinational and whose revenues are tied more into the global economy,” he says. “But the indices are not necessarily representative of the Brazilian market, because in Brazil, there are a lot of non-traded and non-liquid names. The big companies don’t give an investor the exposure to the local Brazilian economy, which is where the opportunities lie.”

First Trust’s Brazil ETF (FBZ) does not exclude the larger, more high-profile Brazilian companies like Petrobras and Companhia Vale do Rio Doce, but it also includes a healthy segment of mid-cap Brazilian names, selected for their industry merit and not for their market cap.

“In the long-term, if you’re an investor looking to get exposure to Brazil for diversification purposes, you should really be looking to get exposure to the local economy rather than through the multinationals, which at the end, all tend to correlate anyway,” Issakainen says.

The real action in Brazil is all happening at the local level, Ashby agrees, and that’s why a targeted, niche approach to investing is the best way to capture the upside. Global X, for instance, has an ETF dedicated solely to the consumer sector in Brazil (BRAQ), designed to get the best out of Brazil’s burgeoning consumer industry and is designed to take advantage of the rising wages and increased purchasing power of the Brazilian consumer.

“The Brazilian economy is large enough so that you can really start isolating different sectors and creating focused plays,” Ashby says. “Anyone whose investment approach is still broad-based is not getting the real domestic Brazil exposure.”

After all, it’s at the local level that the build-up to FIFA 2014 and the 2016 Olympics is going to happen. Getting in there and being a part of that action can be a win-win situation for investors, even if they’re only watching the events on television.

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