Find out how specialists decide between prefixed or IPCA-referenced fixed income – 04/15/2023 – From Grain to Grain

The biggest debate in the financial market is not whether interest rates will fall, but when the decline starts and how intense it will be. In this sense, investors are beginning to rebalance their investments in fixed income. However, a doubt arises, is it better to choose fixed-rate or IPCA-referenced remuneration? I explain below what you need to evaluate to decide.

The prefixed title usually seems more attractive, as we visualize a greater return. In the case of inflation-linked securities, the future IPCA is unknown. So we only visualize the real rate, that is, above inflation.

However, the choice should not be based on the past return, nor on the return we visualize. The decision must be taken based on two factors: risk and economic scenario.

To illustrate, I will use federal government bonds referenced to the IPCA and prefixed. These securities are sold on the Treasury Direct platform or on brokerage desks.

The same decision-making process for federal public securities also applies to private securities such as CDBs, debentures and others. But for the latter, there are tax and return advantages.

For example, while Treasury bonds maturing in 2029 have a return of 12.2% per year or IPCA+5.7% per year, in CDBs you can find a return of 14.5% per year or IPCA+6.7 % per year. In some private bonds, such as debentures of AAA companies, you can earn IPCA+7% pa and exempt from income tax.

This difference in profitability between public and private securities is due to the credit risk of the issuing bank. It is important to remember that those who invest less than R$ 250,000 per issuer, in bank-issued securities, are guaranteed by the FGC. Therefore, for these cases, the risk is low and the average bank CDB is unbeatable in relation to government bonds.

Let’s get back to our goal of explaining how you can decide between fixed rate and IPCA remuneration.

Starting with the scenario factor, you must choose based on what should happen to inflation in the coming years. The selection process is simple, but it will require you to have an opinion about inflation in the coming years.

You must compare your expectations with what is implied by the yield curves at each point in time until the bond matures. The Anbima website helps you with this calculation.

Anbima daily updates the table below, available at the link. In this table you will find the equivalent rate for the government bond referenced to the IPCA and prefixed for each term. In the example below, I only include two deadlines.

In the last column of the table above, there is the implicit inflation rate in the prefixed security, which makes it equivalent to the IPCA-linked security, with the same maturity.

The decision between an IPCA-linked or a prefixed security depends on how your perspective differs from the implicit inflation in the table.

For example, if you believe that inflation from today to six years ahead will be greater than 6.2% per year, you should prefer the inflation-linked title. But, if you think that inflation, in the same period, will be less than 6.2% per year, you should prefer the prefixed bond.

The return on the fixed-rate security is the composition of the IPCA Treasury rate and implicit inflation. For example, using the bond maturing 2029: 12.2% = (1 + 0.057) * (1 + 0.062) – 1.

Therefore, if you believe that inflation until 2029 will be 6.5% per year, if you buy the inflation-linked security, you will earn 12.57% = (1 + 0.057) * (1 + 0.065) – 1. return greater than the yield of the fixed-rate bond of 12.2% per year.

However, the choice cannot just be based on the return. You must also consider the risk. Although it seems that the IPCA is a risk, as you are unaware of it, it is exactly its protection element.

It is important to consider that a risk of a return of inflation due to higher government spending is not ruled out.

Therefore, the title referenced to the IPCA has an element of protection in case the worst happens, that is, a surprise inflation.

Therefore, more conservative investors should prefer IPCA-linked securities.

One way to maintain this IPCA protection and still be able to earn more than the prefixed public bond is to invest part of the fixed income resources in private bonds exempt from IR and referenced to the IPCA.

Remember, a title exempt from IR that yields IPCA+7% per year is equivalent to a taxed title that yields IPCA+9% per year. With an equivalent return of IPCA+9% per year, the risk of the IPCA being low and you becoming frustrated with the preference for the security linked to the IPCA.

This investment in private securities can be carried out through securities or funds that invest in these securities. This second case has the advantage of having greater liquidity and having a specialized team for choosing and monitoring securities.

Michael Viriato is an investment advisor and founding partner of Investor House.

Talk directly to me via email.

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