In the last 12 months, even fixed income is demanding investor patience – 05/13/2023 – From Grain to Grain

Normally, when we say that an investor has to be patient in investments, we are usually referring to higher risk investments such as stocks, real estate funds or hedge funds. However, in the last 12 months, this scope has also expanded to fixed income. I explain what has happened and why patience must pay off.

Most Brazilian investors have become accustomed to the return of the CDI or Selic rate and whenever their portfolios move away from this indicator, even for a short period, there is soon an impulse to change.

However, the short-term relief that change can provide has consequences.

Two effects are responsible for the greatest impact on fixed income portfolios.

The first effect was the deflation that occurred in the second half of last year. The months of July, August and September showed accumulated negative inflation of -1.33%.

This meant that the accumulated variation of the IPCA in the second half of 2022 was only 0.28%. Since 2000, only in the first half of 2020, when the pandemic occurred, have we had such low inflation.

The consequence of this was that IPCA-linked securities posted results well below expectations and below the CDI. Fearing the persistence of this effect, investors fled to assets that remunerate the CDI.

IPCA-linked securities are a fundamental allocation of portfolios with a long-term horizon. It is expected that the CDI and Selic will not yield above IPCA+5% per year for a long time.

Therefore, be careful when preferring the CDI, looking at the short term, as you can compromise years of earnings above the CDI in the long term.

Interestingly, the second effect also only had a parallel in the 2020 pandemic.

Currently, we are experiencing an increase in the spread of credit only observed in the pandemic. O spread credit is the return in excess of the CDI that investors demand to invest in privately issued securities.

In fact, there were unexpected credit events in this first semester. However, as in the pandemic, the level of spread credit rating seems out of the ordinary and tends to revert to the long-term average.

This elevation of spread of credit made bonds and fixed income funds marked to market perform worse in the first quarter of 2023.

Again, running from this effect, at this moment, is throwing away a short-term opportunity that rarely occurs and which tends to be reversed in the short term.

As in the second half of 2020, it is very reasonable to expect that the spread average today at 2.9% per year, measured by the Idex JGP, retreat to 2.1% at the end of the year. This retreat would already promote exceptional gains in bonds and fixed income funds.

Additionally, as occurred in 2021, the decline could continue up to 1.6% at the end of 2024, maintaining the exceptional gains in these assets for at least another year.

Therefore, at this time, also in fixed income, investors should reflect on future earnings before making their choices. Looking to the recent past can encourage decisions that will compromise the long-term result of their portfolios.

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

Talk directly to me via email.

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