Equities

Brazil Hedge Funds Shift to Private Credit Amid Outflows

Brazilian hedge funds shift to private credit as high interest rates lead to 81 billion reais in outflows.

By Max Weldon

7/10, 13:25 EDT
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Key Takeaway

  • Brazilian hedge funds, including Verde Asset Management, are shifting to private credit due to high interest rates and investor redemptions.
  • Hedge funds saw net outflows of 81 billion reais in H1 2023, while private-credit FIDCs had net inflows of 20.4 billion reais.
  • Regulatory changes favoring private credit and the potential for higher returns are driving this market shift despite associated risks.

Shift to Private Credit

Brazil’s hedge funds and equity funds are increasingly turning to private credit as persistently high interest rates lead to rising redemptions and changing investor preferences. Verde Asset Management SA, one of Brazil’s oldest hedge funds, is among the asset managers launching their first-ever credit funds. Other firms making similar moves include equity fund house Drýs Capital and private equity investment firm EB Capital Gestão de Recursos Ltda. This shift is driven by the need to deliver better risk-adjusted returns to clients, as traditional hedge and equity funds face significant challenges.

“We need to deliver good risk-adjusted returns to our clients, and in recent years the hedge fund and equity fund industries had important challenges in relation to this,” said Luiz Parreiras, a partner at Verde. “So we are rethinking processes, rethinking what we can do to deliver those good returns.”

Private credit gained traction globally after the 2008 financial crisis as an alternative to banks, especially as regulators clamped down on risky lending by deposit-taking institutions. Higher interest rates in the US have made returns more attractive, with the market reaching $1.5 trillion this year, up from $1 trillion in 2020, according to a June Morgan Stanley report. The report estimates the market could grow to $2.8 trillion by 2028.

In Brazil, the market expanded when policymakers began aggressively hiking interest rates in 2021 to combat inflation. This forced companies to seek cheaper funding outside banks and offered investors higher returns. Verde, which had 55 billion reais ($10 billion) in assets under management in 2021, now has 22 billion reais.

Performance and Regulatory Changes

An index tracking the performance of hedge funds in Brazil was nearly flat for the first six months of the year, marking its worst first half since 2020 and lagging behind the 5.2% gain for the benchmark CDI rate over the same period. In comparison, an index for less risky corporate bonds returned 7.29%. Hedge funds experienced net outflows of 81 billion reais in the first half of this year, according to Anbima, the nation’s capital-markets association. A new rule increased the tax burden on wealthy investors using exclusive funds to invest in hedge funds while cutting taxes for private credit funds.

Equity funds also faced challenges, suffering along with Brazil’s slumping stock exchange. They had 100 million reais of withdrawals as the benchmark Ibovespa stock index dropped 7.66%. In contrast, FIDCs—funds that represent part of Brazil’s private-credit industry—had net inflows of 20.4 billion reais. FIDCs, which are unique to Brazil and similar to the US securitization market, invest in credit packages with shares sold to investors in tranches that can be separated by risk.

“FIDCs are rising stars, and now that regulators allow retail clients to invest in them, the market is going to explode,” said Samer Serhan, a partner at Brazilian credit-fund manager Jive Investments, which has 18.5 billion reais in assets.

Risks and Opportunities

Despite the growing interest in private credit, experts caution that some investors may not fully understand the complexities of FIDCs. “Each FIDC is different from the others, and their structures are not obvious, they are very tough to analyze,” said Ricardo Binelli, a partner at Solis Investimentos, which has about 16 billion reais under management. Understanding these details is crucial for managing risk, he added. His firm is preparing to launch a FIDC that will buy shares of other FIDCs, aimed at retail investors.

High interest rates present opportunities to buy credit at attractive returns but also raise default risks. “Just because someone knows how to trade equity doesn’t mean they know how to invest in credit,” said Rafael Fritsch, a partner and chief investment officer at Root Capital. “To buy credit you need a neurotic mindset, to think all the time that you may lose.”

Verde started investing in credit in 2006 through its hedge funds and has been building experience and teams ever since. In May, it launched a FIDC named Ipe, initially distributed only on platforms run by Banco BTG Pactual SA for institutional and qualified investors. The goal is to reach 1 billion reais by the end of 2025, Parreiras said. Verde’s next plan is to launch a fund that buys tax-exempt infrastructure bonds.

Street Views

  • Luiz Parreiras, Verde Asset Management (Cautiously Optimistic on private credit):

    "We need to deliver good risk-adjusted returns to our clients, and in recent years the hedge fund and equity fund industries had important challenges in relation to this. So we are rethinking processes, rethinking what we can do to deliver those good returns."

  • Samer Serhan, Jive Investments (Bullish on FIDCs):

    "FIDCs are rising stars, and now that regulators allow retail clients to invest in them, the market is going to explode."

  • Ricardo Binelli, Solis Investimentos (Neutral on FIDCs):

    "Each FIDC is different from the others, and their structures are not obvious; they are very tough to analyze. Understanding those details is key to managing risk."

  • Rafael Fritsch, Root Capital (Cautiously Pessimistic on investing in credit):

    "Just because someone knows how to trade equity doesn’t mean they know how to invest in credit. To buy credit you need a neurotic mindset, to think all the time that you may lose."

  • Marcelo Mifano, Vinci Partners Investments Ltd. (Neutral on high interest rates impact):

    "High interest rates bring opportunities to buy credit at attractive returns but also raise default risks."