Understand what happened to fixed income this September – 09/30/2023 – From Grão to Grão

Public and private credit securities (except bank ones) and fixed income funds must be marked to market. This rule is recent and its effect still confuses investors. For example, in the month of September, the average of fixed income securities referenced to the IPCA and prefixed rates and funds that buy these securities performed below expectations. I explain the reason for this return and what to do.

I will focus on bonds and funds referenced to the IPCA, as they are those where there is a great opportunity. Not that there aren’t interesting prefixed bonds, but those with attractive rates are more restricted.

There are three federal public bond indices referenced to the IPCA: IMAB5, IMAB5+ and IMAB. The difference between them is the maturity date of the securities in the portfolio being less than or greater than 5 years. IMAB encompasses everyone.

As I have written in the past, IMAB5 (term less than 5 years) is the most interesting of them. The justification is its ability to present a better return balance with low volatility in returns. However, low does not mean no volatility.

Above I present the graph of the evolution of an investment in IMAB5, IHFA (Brazilian multimarket fund index) and CDI, over the last 15 years. The IMAB5 beats them all.

In the month of September, the profitability of IMAB5, IMAB5+ and IMAB were 0.1%, -1.9% and -1%, respectively.

This lower-than-expected profitability was marked by two relevant variations in a short space of time.

Interest rates on American bonds rose sharply during the month. This increase had several reasons, including the strong rise of more than 7% in oil prices in the month, the tougher speech from the American Central Bank and the resilience of the economy’s growth.

The graph above shows the variation in the 10-year American interest rate, which went from 4.10% per year to 4.60% throughout September.

The FED’s speech also brought volatility to the risk of emerging countries. The graph below shows how the risk of emerging markets and Brazil rose shortly after the FED president’s speech on September 20th.

Note that the movement was not something specific in Brazil as we often want to attribute.

Although the cause is not specific to Brazil, there is something unique to us that should cause a reversal of this performance.

The Central Bank in Brazil has already made it clear that the Selic should continue to fall by 0.5% in the next meetings. The interest rate reduction here is justified, as inflation is within the BC’s target range and economic growth, anticipated by the IBC-BR, has cooled.

Selic is expected to be around 10% per year in mid-2024.

Therefore, the increase that occurred now should converge downwards following this movement in the Selic. With this reversal, all the profitability lost from September should be recovered in the coming months.

As I’ve mentioned in the past, no matter which month you started investing, in five-year windows, IMAB5 has never lost the CDI in the last 20 years.

Also, in 98.3% of the times when IMAB5 lost the CDI like now, it had a return superior to the CDI in the following 24 months. This average gain was 121.4% of the CDI, but reached 223.8% of the CDI.

This possibility of excess return from IMAB5 increases when investing in private securities and funds that invest in these securities, as their rates are on average 20% higher than those of public equivalents.

Therefore, take advantage of rising interest rates to lock in future gains.

Do you want to understand the opportunities in the fixed income market in more depth? Join me in a live lecture with the executive director and manager responsible for ARX Investimentos’ Private Credit strategy this Tuesday (03/10) at 6 pm. Sign up here.

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

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