International fixed income yielding Dollar + 7.5% per year is it worth it? – 08/26/2023 – From Grain to Grain

The recent appreciation of the Real from R$5/Dollar to R$4.87/Dollar, together with the rise in interest rates abroad, raises doubts among investors. The main one is: has this been a good investment in recent years? I simulate these fixed income investments with alternatives in Brazil with the same risk and lower and explain what seems more appropriate in terms of return per risk.

Bonds of Brazilian companies with 10 years of maturity were traded abroad this week between 6.5% and 8.5% per annum. For example, Petrobras bonds maturing in 2033 were trading at 6.8% per year in dollars. The 2031 CSN bond paid 8.4% per year in dollars. We can assume an average interest rate of 7.5% per year in dollars for good Brazilian companies.

That rate is one of the highest for these bonds in the last 16 years. This occurs because the interest rate on the 10-year US government bond, which is the reference, has not reached the level of 4.3% per year since 2007.

However, our interest rates are also still very high. Therefore, it is important to understand, considering the interest rate on bonds in Brazil and abroad, which would have been the best investment in the last 24 years, that is, since August 1999.

Investing in a security of a Brazilian company issued in Brazil or abroad carries similar risk when using the credit risk criteria.

However, when the criterion is market risk, securities abroad are riskier, as the exchange rate has greater volatility than the IPCA or the CDI, which are the indexation references in Brazil.

Thus, investing abroad turns out to be more risky, as it has similar credit risk, but greater market risk.

Many fixed income securities issued by companies in Brazil have the advantage of exemption from income tax for individuals. Currently, these securities are traded at an average rate of IPCA+6.5% per year. Let’s use these bonds to compare, as they have the same credit risk but less market risk.

I will also compare it with three other possibilities with lower credit and market risk. CDBs, within the FGC guarantee, yielding IPCA+6% per year, 115% of the CDI and 100% of the CDI, are investment alternatives for comparison.

The graph above shows the evolution of an investment of R$100,000 in August 1999 until today in the four fixed income investment alternatives in Brazil and in the red line the investment in Brazilian Bonds yielding a dollar +7.5% per year.

To keep all investments on the same comparison basis, I considered all investments with their net income from income tax.

Note that net of income tax, international investment lost even the CDI.

The worse result of international investment is explained in part by the higher income tax burden on this application. Also, one should consider that the exchange rate tends to yield less than the IPCA in the long run.

Bear in mind that the Brazilian investment risk closest to international fixed income, that is, in bonds corporate assets are debentures, CRAs and CRIs exempt from IR, represented in the graph by the blue line. Despite the latter having a lower risk, they presented a final result of more than double that of bonds in dollar.

The investment of R$ 100 thousand in a debenture exempt from income tax yielding IPCA+6.5% per year ended the period with an amount of R$ 1.68 million. While the same investment in a dollar yielding +7.5% pa, when taxes are removed, reached only R$ 0.78 million.

Application	Annualized income tax net return (from the last 24 years)
IPCA + 6.5% (tax exempt)	12.50%
115% CDI (Net Income Tax)	10.98%
IPCA + 6.0% (Net Income Tax)	10.12%
CDI (IR net)	9.49%
Dollar + 7.5% (net income tax)	8.91%

The annualized and net income tax return for the entire period analyzed for the five fixed income alternatives is shown in the table above.

We do not know for sure how the dollar, CDI and IPCA variables will behave in the future. However, a sample of almost half a century is reasonably good for comparison, as it includes favorable and unfavorable moments for all these indices.

In this sense, I consider corporate credit investments from good companies with rates above IPCA + 6% pa exempt from IR or above 14% pa fixed-rate as good investments for the long term. Mainly, considering the prospect of falling interest rates that should occur in the coming years.

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

Talk directly to me via email.

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