Too many alternatives can result in a worse choice for fixed income – 02/25/2023 – From Grão to Grão

We tend to imagine that having more alternatives is always better. However, this is true when there is full knowledge about investment options, economic expectations and their consequences. Even in fixed income, uncertainty and excess possibilities can lead to worse choices.

This weekend, I ran into this dilemma at an airport in front of a more modern coffee machine. The machine had more than 5 initial coffee alternatives that, when selected, were subdivided into another 6.

That is, there were 30 possibilities for a simple coffee.

The same goes for investments. Even when we want to invest only in a simple fixed income.

With the doubt, many end up taking refuge in savings or in what they had positive past experience and lose better investment alternatives.

The choice of the fixed income index already raises doubts. See with a test involving only 8 of the possible fixed income alternatives and not 30 like the coffee machine.

Which return should provide better and worse results in a one-year horizon?
a) Prefixed at 14.5% per year;
b) Prefixed at 12.50% per year exempt from IR (LCA and LCI);
c) Post fixed at 117% of the CDI;
d) Post fixed at 95% of the CDI;
e) Selic Treasury;
f) Treasury IPCA 2029 (IPCA+6.1% pa);
g) IPCA+7% pa (CDB);
h) IPCA+7% pa exempt from income tax (Debentures, CRAs and CRIs).

These are just some of the possible fixed income options. With the doubt, many end up running for savings and losing better alternatives.

The choice becomes even more complicated when you need to choose investments for a horizon of 5 years or more. For example, until 2029. Then respond.

Which return should provide better and worse results in the horizon until 2029?
a) Prefixed at 14.5% per year;
b) Prefixed at 12.5% ​​per annum exempt from IR (LCA and LCI);
c) Post fixed at 117% of the CDI;
d) Post fixed at 95% of the CDI;
e) Selic Treasury;
f) Treasury IPCA 2029 (IPCA+6.1% pa);
g) IPCA+7% pa (CDB);
h) IPCA+7% pa exempt from income tax (Debentures, CRAs and CRIs).

The selection is not simple, as it depends on expectations about the CDI and IPCA in the period. Also, it is necessary to consider the IR tax benefit for exempt instruments.

According to market expectations, it is possible to project a scenario for the CDI and IPCA until 2029, as shown in the figure below and marked in green.

With these expectations, it is possible to compose the returns and verify which application should present the best and worst results.

The figure above presents the composition for the eight possibilities in 2023 and until 2029.

It was simulated how much each of these alternatives could provide with an investment of R$ 50 thousand. For instruments exempt from IR, the effect of the profitability of an equivalent gross application of IR was considered for comparison.

For a one-year horizon, the best alternative would be an IPCA-linked and IR-free security that would have a gross IR equivalent return of 16.3%. This return can be found in private securities such as debentures, CRIs and CRAs.

This same title would also be the best alternative for horizon until 2029.

It is important to remember that these securities are not guaranteed by the FGC. Therefore, they are at greater risk. However, if it is made in issues of companies with good credit quality and divided into more than one issuer, this risk is interesting.

Going back to the one-year horizon, securities referenced to the CDI with a return of 117% of the CDI and 95% of the CDI exempt from IR prove to be excellent alternatives. It is possible to find CDBs and private credit funds with returns of 117% of the CDI. There are also LCIs and LCAs on the market with a return of 95% on the CDI without IR.

In this same short-term horizon, the investment with the lowest return would be in the IPCA 2029 Treasury bond. This same bond is shown as the second worst alternative with a 2029 horizon. The worst in this period was the Selic Treasury.

Note that, even considering a relevant drop in the Selic and CDI until 2029, the Treasury IPCA 2029 would lose against an LCI and LCA with a return of 95% of the CDI and a CDB with a return of 117% of the CDI.

It is worth mentioning that the results depend on the scenario for the Selic and for the IPCA. We are aware that these indicators may undergo significant changes due to price dynamics and even due to tax changes, as we saw in 2022.

In order to simulate other scenarios and evaluate the results of the investments, I provide in this link the spreadsheet that supports the figure above. In this worksheet, you can change the cells marked in green and yellow, simulating scenarios and possibilities of different fixed income investments.

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

Talk directly to me via email.

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