Understand why selecting the investment horizon is so important to invest in fixed income – 09/02/2023 – From Grain to Grain

When investing in fixed income, if we do not pay attention to the investment horizon, we will end up frustrated in the short or long term. Even worse, it can lead to wrong decisions when patience in waiting would be recommended. I explain the reason and which index should present the best result in each period.

Usually, when we think about investing in fixed income, we want to earn the CDI every month.

This is possible, but it can be inefficient.

The only way to earn from the CDI in any period is by investing only in this index. However, when you do that, you lose the opportunity to earn more in the medium and long term.

Hence the importance of establishing the investment horizon well.

The investment horizon is the time in which resources are expected to be redeemed for use in some other purpose.

The horizon may not be unique for all resources. For example, a relevant portion may have a horizon of more than 10 years and aim to meet the retirement reserve.

However, a portion may be for the short term, that is, less than two years and have the purpose of paying off commitments within this period. For example, it can be for a trip plan, car purchase, postgraduate course and others.

I will only make the comparison with public bonds, but it is important to understand that in private bonds, the reasoning is the same and it is possible to have higher returns and exempt from income tax.

Fixed income securities can be divided into three categories: post-fixed, IPCA-linked and fixed-rate.

The post-fixed are those referenced to the CDI and Selic. In the case of government bonds, they are referenced to the Selic. Both indexes, Selic and CDI have the same return.

Right now, the Daily Selic rate is at 13.15% per annum, but is expected to decline by 0.5% in each of the next six meetings of the Monetary Policy Committee (COPOM). The next meeting will be on the 21st of September. In June of next year, the Selic should be at 10.0% per annum and at the end of the year 9.5% per annum.

Even with all this expected drop, by the end of 2024, a bond that yields 100% of the CDI should yield more than a bond that yields IPCA+5.23% per year. The security with this rate of return is the Treasury IPCA 2029, that is, referenced to the IPCA.

Therefore, when marking the acquisition rate, the security referenced to the CDI or Selic should yield more in the short term, that is, until the end of 2024.

The result is reversed from 2025 onwards. Perhaps you ask yourself: why not keep everything in CDI or Selic until the end of 2024 and then switch to what will give you more?

Because at the end of 2024, when the Selic rate has dropped to 9.5% per year or less, there will no longer be the same rate referenced to the IPCA to invest in. It will be lower.

For the horizon of 2029, which is the maturity of the IPCA Treasury bond, the expectation is that the yield on this bond will be 118.5% of the Selic rate. Therefore, better than the title referenced to Selic. However, this premium or gain comes at the expense of a lower return now.

In other words, those who invest with a longer term horizon, for example 2029, will have a better return if they invest in securities linked to the IPCA, but they should be frustrated with the loss of the CDI in the short term.

On the other hand, those who invest in the short term should allocate at Selic, but if they are going to invest at Selic for a longer time, for example, until 2029, they will be frustrated for not having invested better for the entire term.

In this comparison, I considered the return on acquisition rate. However, in mark-to-market, long-term bonds tend to anticipate and incorporate future gains as the scenario becomes effective.

So, yes, when marking securities to market, it is possible that the IPCA-linked security I mentioned already anticipates part of the additional gains between 2025 and 2029 for next year. But that would be a riskier bet.

Therefore, considering the markup at current acquisition rates, for a resource that must be used in a period of less than 2 years, the safest application is a title referenced to the CDI and Selic. For a longer term, the reference to the IPCA stands out.

And the prefix? These bonds typically carry a premium on both the real interest rate and expected inflation. For example, the government bond rate of 10.9% per annum should result in a full-period return of 132% of the Selic. So even better than the previous ones.

However, this bond carries the risk of a spike in inflation, which is common in Brazil, which could make it worse than the IPCA-linked bond.

I emphasize again that private bonds carry a premium on these rates. For example, it is possible to invest in CDB, with a FGC guarantee and a return of 115% of the CDI with a 2-year term. Likewise, it is possible to invest in private securities with fixed rates of 14% per year and IPCA+6.5% per year exempt from income tax.

In all cases, the first step is to define which portion to leave for a short-term horizon and which to keep for a longer term. Thus, you can have a more efficient balancing throughout the period.

However, it is important to understand that to have a higher return in the long term, you have to pay a lower return price in the short term.

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

Talk directly to me via email.

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