Carnival looking to come early for Brazilian asset managers

Prior to the election of the new Brazilian president Jair Bolsonaro, in October 2018 after winning 55 per cent of the vote, there had long been a trend among Brazilian fund managers to allocate capital offshore to invest outside of the country. Now, as the markets begin to stabilise, investors – both locally and globally – are starting to reconsider Brazil again for investment opportunity.

For fund administrators such as the Maitland, who have become increasingly active in Brazil over the last four years, this shift represents a significant opportunity to assist managers with their offshore investment vehicles – typically designed to allow for trade in currencies outside the Brazilian real, however now with a focus back on Brazil, managers will be looking to raise capital outside Brazil, typically fed through a feeder entity. 

Benjamin Reid, Senior Business Development and Client Service Manager for LatAm, confirms that over the last eight months alone, Maitland’s AuA has grown by approximately USD1 billion with respect to Brazilian fund clients with a further USD500 million expected in the coming months. Moreover, he asserts that Cayman is the jurisdiction most commonly used by Brazilian managers looking to access offshore markets.

“By all indicators, President Bolsonaro is most likely going to be pro-markets and give the financial sector the much-needed boost they have been waiting for since President Dilma’s impeachment,” says Reid. “If we look at how the markets have reacted since his confirmation, it has been positive, and this has lead a lot of interest for new mandates since the election. From a capital raising perspective, this couldn’t have been a better outcome.

“One space in particular where managers are taking advantage of cheaper, distressed assets is private equity, where launches from managers such as Jive Investments and Starboard Restructuring Partners have been particularly interesting.”

The end of the stagnant years?

Brazil’s investment funds market is highly regulated and on a par with Europe. Liquid funds require investment managers to deliver a daily NAV, which has to be published to the regulator each morning. With the Brazilian Real being a non-deliverable currency, the requirement sets out that Brazilian FX futures and options that are non-deliverable must be settled domestically. For Brazilian fund managers running liquid strategies and wanting to develop a hedge they must set up separate offshore investment vehicles – Cayman has historically been the jurisdiction of choice for these vehicles given its pro-business and easy of working mentality.

While most markets suffered heavily during the global financial crash in 2008, Brazil weathered the storm well and arguably had some of its best years from 2008 through to 2013. However, as 2014 brought about some change and just as Brazil was getting over their post-carnival hangover, the country was gripped by what is conceivably the biggest global corruption scandal seen to date. The Lava-Jato scandal sent Brazil into a nosedive and its financial markets suffered the knock-on effect. 

2016 saw the country hit rock bottom when Dilma Rouseff, Brazil’s 36th president became the second President to be impeached (followed by Fernando Collor de Mello back in 1992). The fall in the Real/USD ratio (from 1.98 in early 2013 to 4.10 in 2015) coupled with high volatile markets lead to a flight to safety and a shift from pure domestic-focused investing for most liquid managers. 

The Cayman Islands, again through its deep history with Brazil, offered managers with solutions to weather the storm. 

Moving into 2019, it would appear the pendulum is beginning to swing back the opposite way. Now, says Reid, “for the first time in a while we are seeing managers looking to raise more money in Brazil as well as offshore.” 

Managers are setting up offshore vehicles to attract global investors and invest their capital back into Brazil. This is especially true of the private equity space. 

Illiquid leading the charge over liquidity when it comes to US Capital

“A number of prominent US private equity managers are taking sizable bets on the Brazilian economy, and they are using Cayman and Canadian vehicles to achieve this in joint ventures with Brazilian fund managers. Distressed assets and real estate have been a big focus of investment activity,” says Reid. 

Earlier in 2018 for example, Apollo Global Management entered into a strategic partnership with Starboard Restructuring Partners to pursue corporate special situation and distressed investment opportunities in Brazil. 

“What we have seen a lot of from Brazilian fund managers in the illiquid space looking to raise Capital offshore is the use of a closed-ended feeder fund set up as (Cayman) limited partnerships to mirror the terms of a domestic Brazilian Fundo de Investimento em Direitos Creditórios (‘FIDC’) fund,” explains Reid.

When raising outside capital to invest back in to the country into the illiquid space, Brazilian fund managers typically set up a master feeder structure with two feeder funds; one in Cayman and one in Delaware to segregate US and Non-US-taxable investors. 

The Cayman “master” acts as a feeder back into the Brazilian fund (typically passing through a Delaware LLC) that is responsible for opening the non-resident Brazilian bank (4373) account. All told it is quite a convoluted process. However, with the prospects of some good years ahead, “we are seeing managers taking the plunge and setting up structures and planning road shows for Q1 2019,” says Reid.

“The Brazilian local fund (typically FIDC’s) is archetypally where the assets are held, with the US Delaware Master fund and Cayman feeder structured as limited partnerships being mainly used for Investors. We haven’t seen the Cayman LLC being implemented that often. It would be different if the Cayman entity was being used to hold the underlying investments but it is only used as a capital raising vehicle.

“The ones we see making the most noise are these bigger name brands. That said, over the last six months we have seen some smaller managers setting up offshore funds. We’ve onboarded two big names in the last few months and a handful of managers launching with USD20 million or thereabouts, in the hope of attracting additional offshore capital.”

Reid says that Brazilian fund managers historically turn to Europe on a less frequent basis than Cayman because of the cost and complexity. Even the most sophisticated fund managers struggle with European fund structures – diversification regulations in Luxembourg, the need to have a risk manager and a locally appointed custodian and depository create an added layer of costs which if you are predominately targeting the US for capital, doesn’t make sense. 

“This said, with the OECD putting pressure on offshore jurisdictions some managers are of the impression that jurisdictions like Luxembourg offer better solutions. Cayman, though, is still where we see the majority of our mandates coming from,” concludes Reid.

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