Find out when it’s worth exchanging fixed income with a lower return for another one with a higher return – 02/26/2023 – De Grão em Grão

The economy’s basic rate, Selic reached its minimum in 2020. However, since 2018 its income was already less than half of the current one. Thus, those who bought fixed income securities with long-term maturities between 2019 and 2022 carry in their portfolio rates of return on acquisition that are much lower than the current ones. Thus, many question whether it is worth exchanging these bonds for others with higher current rates.

The problem is found in fixed income securities prefixed or referenced to the IPCA.

In 2020, when Selic was 2% per year, it was possible to invest in prefixed CDBs with rates of up to 8% per year or referenced to the IPCA with a return of IPCA+5% per year.

In the same year, 2020, public securities maturing in 2035 were traded with a return of IPCA+4% per annum. The prefixed ones were traded at less than 7% per annum with maturity in 2031.

At that time, both public and private bonds provided an enormous return when compared to the Selic rate of 2% per year. Also, it was not expected that the Selic could return to the level above 10% in any forecast horizon. Therefore, they looked interesting.

However, the worst happened, that is, the Selic rose to the current level of 13.75% per annum. So, what should investors do with those securities acquired in that past moment?

The answer is simple, but it has an exception to the general rule.

The first step is to understand whether the acquired security is marked to market or at the acquisition rate.

If the security is marked to market, there is nothing you can do, that is, you must keep it in your portfolio. The price of your bond has already dropped so that today’s yield to maturity already matches the highest rates at the time.

The exception to the above indication is if the maturity of the bond is short-term, that is, up to two years. In this case, if your investment horizon is long-term, that is, more than 5 years, consider selling the current security and changing it, locking in the highest rate at that moment for a longer period.

If your security was purchased on the Treasury Direct platform, then it is certainly marked to market. Therefore, in these cases, you must maintain or extend the term as mentioned above.

You can also have government bonds purchased from brokerages and which are marked on the acquisition rate. In these cases, it is also not worth selling unless you want to extend the term and lock in higher rates for longer.

Bank securities such as CDBs, LCs, LCAs and LCIs are marked at the acquisition rate. In this case, an analysis based on the bond’s selling rate and term is required.

There is usually some penalty on the sale of bank securities.

Therefore, switching to another security of similar or shorter maturity is not recommended. You would end up selling your bond for a rate greater than the reinvestment rate, i.e. you would make a loss on the exchange.

The exception, again, would be for the objective of lengthening the term of the bond and locking in higher interest rates for a long time.

With the same objective, it is worth evaluating IR-exempt securities such as debentures, CRAs and CRIs that have maturities of more than 10 years.

In this case, the result may be favorable as it locks in high rates and exempt from IR for a very long term. However, it is important to pay attention to the greater risk of these securities that do not have a guarantee from the FGC.

Note that it usually does not compensate for the early sale of a fixed income security purchased at a lower rate in order to exchange for another one with a higher rate, but which has the same characteristics and similar maturity period.

Remember, the sale of your security will always be carried out in the market and whoever acquires it wants to have the highest yields prevailing today. Therefore, you would at best have the same result by keeping or switching. However, normally, this exchange would be at a loss, as there is a bid and ask spread.

Usually, the switch only makes sense for the purpose of lengthening the term to lock in today’s high rates for a longer term.

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

Talk directly to me via email.

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