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The Dark Side of Passive Investing

Passive investing ranks among the most successful innovations of modern finance. We do not deny that is an appealing concept. In fact, we fully acknowledge that:

a passive manager is likely to outperform an active manager chosen at random, assuming the latter involves higher fees and costs
passive investing is highly transparent, as performance can be evaluated against an index that is independently calculated by a third party
a passive approach can be applied on a large scale because of its high liquidity
passive investing may be considered a safe choice, because by pretty much guaranteeing a return close to the index it eliminates the risk of having to explain a large underperformance sooner or later

However, we also have some serious concerns with regard to passive investing. We argue that if these concerns are also taken into account, the case for passive investing is not so clear-cut anymore.

Concern #1: passive investors are free-riders

Lorie and Hamilton (1973) already noted that the market can only be efficient if a large number of investors actually believe it to be inefficient, the so-called efficient markets paradox. In other words, the existence of a large number of active investors is a necessary requirement for efficiently functioning capital markets. Active investors continuously trade on perceived mispricings, thereby ensuring that the price of each security always reflects the market’s best assessment of its (unobservable) true value, and that the market is highly liquid. As such, active investors play a vital role in financial markets. Passive investors, on the other hand, are basically free-riders, as they do not make any attempt to assess the fair value of a security. Instead, they assume that active investors have done their homework properly, which enables them to simply accept and mechanically follow the observed security weights in the capitalization-weighted market portfolio.

Active investing: a moral responsibility?

A famous quote from Benjamin Graham is that the market can be compared to a voting machine. This is a useful analogy, because, similarly to passive investing, voting in a parliamentary democracy involves a big free-riding problem: voting is basically futile so long as millions of others vote. Free-riding appears to be a rational alternative: instead of going out to vote, spend the time on a more useful activity, such as family or a hobby. Interestingly, however, most people are well aware of this logic but still choose to put time and effort into voting, arguably because they see this as a moral responsibility in a parliamentary democracy. In the same spirit, active investing may be seen as a moral responsibility that comes along with a market economy. An efficient and liquid market benefits everyone, but because this can only arise as a result of large-scale active investing, perhaps every investor should feel obliged to contribute.

Concern #2: passive investing goes against proven factors

Our second concern with passive investing is that it goes against proven factors. The literature provides extensive evidence that securities with certain factor characteristics tend to exhibit a very poor performance, while other characteristics appear to be rewarded with better returns. Because passive investors simply buy the capitalization-weighted market portfolio, which contains all securities, they basically choose to ignore such evidence. In other words, a passive approach involves intentionally investing large parts of one’s portfolio in segments of the market that are known to be associated with disappointing historical performance characteristics.

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If you believe in factor premiums, passive investing does not make sense

The logical implication of factor premiums is not to adopt passive investing and thereby intentionally invest large parts of one’s portfolio in segments of the market that are known to be associated with very poor historical performance characteristics, such as growth, past-loser and high-volatility stocks. In fact, it makes more sense to actively avoid unattractive segments of the market and seek more exposure to attractive segments.

David Blitz, PhD, is Head Quantitative Equities Research at Robeco.

The article can be found in this link and in the attached document

Korea’s Expanding Fund Networks

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Corea y su primer supermercado de fondos online — Photo: RKG1H. Korea's Expanding Fund Networks

Most developed markets have long offered numerous and diverse channels for asset management products—except in South Korea. Until very recently, there have really been just two primary channels in South Korea—banks and brokerage companies, which suffer from conflicts of interest, as they are motivated to sell products run by their affiliates. As of late last month, investors got a new option: Korea’s first online fund supermarket.

The newly launched online fund platform, known as Fund Online, seeks to confront the proprietary sales approach of the big bank and brokerage firms by providing an alternative that is more neutral and widely available. Additionally, Fund Online, which serves smaller, independent asset managers, aims to reduce costs for investors, and create a more competitive distribution landscape.

The concept of investing as a long-term means of wealth generation is slowly developing within Korean households. When I first started working in the industry in Seoul in 2005, investors were beginning to build unrealistic expectations because of the performance of the Korea Composite Stock Price Index. Retail investors typically held high expectations for substantial double-digit returns, so fees of a few percentage points were less of a concern. At the time, fund firms charged fees as high as 2.5%. Particularly popular at the time was a so-called “installment-type equity fund,” which investors could buy into with a fixed contribution deducted from their monthly paychecks. It was a notable phenomenon, as the average Korean found equity funds to be novel new instruments for savings.

After the Global Financial Crisis of 2008, retail investors became more cautious and, not surprisingly, fee-sensitive. Consequently, the average total expense ratio of actively managed equity funds in Korea dropped to 1.41% in 2012. Of that, commissions to distribution channels lost the biggest share.

Fund Online, which is privately held, hopes to allow retail investors more investment choices and also provide better transparency over fees. The fund supermarket says it has halved sales channel commission to approximately 0.35%. In a related development, the Korean government has introduced the concept of Individual Financial Advisor (IFA) to help provide unbiased investment advice to retail investors. Currently, the average Korean investor is accustomed to getting advice for “free” from their local bank branch, where they hold bank accounts; but, as previously implied, few things come for free. A symbiotic relationship between the fund supermarket and the IFAs, if it develops, should lead to greater transparency for the industry, and may promote the virtues of long-term investing—a welcome development for Korea’s capital markets.

Soo Chang Lee, CFA, Research Analyst at Matthews Asia

The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.

Hispania Acquires 213 Apartments in Barcelona from Santander’s Real Estate Fund

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Hispania compra al fondo inmobiliario de Santander 213 viviendas en Barcelona — Barcelona Port. Photo: Flickr, Creative Commons. Hispania Acquires 213 Apartments in Barcelona from Santander’s Real Estate Fund

Hispania Activos Inmobiliarios, through its subsidiary Hispania Real Socimi, has acquired -in a deal out of the market- from Santander Banif Inmobiliario F.I.I., 213 apartments located in the residential complex Isla del Cielo, in Parque Diagonal Mar in Barcelona. The deal has amounted to 63.8 million euros, fully paid with Hispania’s own funds. The acquisition also includes 237 underground parking slots within the same residential complex.

Isla del Cielo residential complex comprises 2 apartment towers – Tower A, with 17 floors and 104 flats and Tower B with 21 floors and 150 flats- as well as an underground car park. The complex also has communal garden areas and outdoor swimming pool. The built surface of the complex amounts to approximately 38,000 square meters, including the underground floors. The acquisition includes all 150 apartments located in Tower B, 63 apartments emplaced in Tower A and 237 underground parking slots.

The acquired apartments currently enjoy an occupation rate of 90% by means of rental contracts.

Diagonal Mar is located in Barcelona’s seafront, at the beginning of the emblematic Avenida Diagonal, and represents the most relevant real estate development in the city. The area includes a commercial area of more than 88,000 sqm, one of the biggest shopping malls in Catalonia, 68,000sqm of office Surface, a number hotels and the second biggest park in Barcelona, with a 14 hectares surface, designed by Enric Miralles, where Isla del Cielo is located.

Hispania business plan’s main focus is to invest in the asset and to increase benefits and services in order to transform it into an emblematic complex of apartments for rent in Barcelona, intended for professional and international customers.

“With this second acquisition in Hispania, we remain loyal to our strategy of investing in quality assets with a clear potential for value creation by means of and investment and management plan. Isla del Cielo, as a flat for rent complex, stands as one of the main competence and focus areas of Hispania. We are very excited with the opportunity of creating value with these assets, which are located in an area of great projection in Barcelona”, said Concha Osácar, Board Member of Hispania and co-founder of Azora, Hispania’s investment manager.

Azora, investment manager of Hispania, has extensive experience in the investment, repositioning and management of residential assets for rent, by means of its team, made up by more than 96 professionals, expert in residential buildings, who manage around 100 buildings comprising more than 10,200 apartments on a leasehold basis.

Finally, Hispania has informed that last 1^st of April, 2014 it established, through deed of incorporation, the subsidiary Hispania Real -100% of the latter-which has agreed to fall under the special tax regime envisaged for real estate investment listed companies (SOCIMIs). This has been communicated to the tax authorities to all appropriate effects. It is therefore expected that Hispania Real acts as “Subsidiary Socimi”, as conveyed in the informative prospectus prepared by Hispania on the occasion of the initial public offering of its shares in the Spanish Stock Exchange Market.

MFS Hosts its Global Analyst & Portfolio Manager Forum in London With the Assistance of 50 Delegates from Around the World

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MFS reúne en Londres a 50 profesionales de todo el mundo para exponer su perspectivas de inversión — Fotos: Funds Society. MFS Hosts its Global Analyst & Portfolio Manager Forum in London With the Assistance of 50 Delegates from Around the World

MFS Investments hosted their 2014 Global Analyst & Portfolio Manager Forum at Syon Park in London last week. The event was attended by approximately 50 delegates representing European, US, and LatAm markets. In attendance were delegates from Germany, Italy, Spain, Switzerland, France, the UK, the US, and Uruguay, Columbia, Chile, Peru, and Brazil.

MFS had portfolio managers present on nine of their Meridian Funds, and also provided a Global Market Outlook as well as their investment philosophies on Lengthening Your Time Horizon and Active Risk Management.

From the delegates perspective, a highlight of the forum was the ‘meet the managers’ breakout sessions where attendees could attend smaller, more intimate sessions with the portfolio managers. Concurrent sessions were conducted focusing on emerging markets equities, emerging markets debt, and developed equity markets.

Please click on the video to see pictures of the event.

Madoff Victim Fund (MVF) Announces Receipt of More Than 50,000 Claims

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Richard C. Breeden, the Special Master on behalf of the U.S. Department of Justice administering the Madoff Victim Fund (“MVF”), has announced preliminary results for the first stage of the MVF claim process. As of the close of the claim period on April 30, MVF received more than 51,700 claims from investor victims of the fraud at Madoff Securities. Claimants from 119 countries reported aggregate unrecovered net investment losses of more than $40 billion. MVF is the official vehicle for distributing slightly over $4 billion in forfeited assets recovered by the U.S. Attorney for the Southern District of New York from actions against persons involved in the fraud at Madoff Securities.

The claims received have not yet been reviewed to eliminate ineligible, duplicate or overstated claims, which MVF expects to be substantial. In particular, MVF received numerous filings on behalf of banks and other managers of pooled investment vehicles that are not generally eligible to participate. As a result, the final totals are expected to shrink considerably before payments commence. However, the flood of claims submitted to the MVF gives a new indication of the size and global reach of the Madoff fraud.

Special Master Richard Breeden said: “The MVF claims showed a strikingly larger group of victims — with much larger losses — than anyone previously knew to exist. Other than the Gobi desert and the polar icecaps, few places on earth seem to have escaped the scourge of this fraud. This fraud was of epic, and truly global, proportions.”

To date:

MVF has received more than 51,700 claims.
Claims came from victims in 119 countries.
Projected total claims of more than $40 billion in net investment loss.
Aggregate net losses are split almost evenly between U.S. and non-U.S. victims.
Victims submitted more than 3 million pages of backup documentation

MVF received more than 43,500 claims from individuals who did NOT file a claim in the Madoff Securities bankruptcy proceedings. Overall, MVF has received more than three timesas many claims as were filed in the Madoff bankruptcy proceedings (and roughly 20 times more claims as were allowed in the bankruptcy proceedings).

Based on preliminary review, approximately 77.5% of claims were submitted by individuals reporting losses of up to $500,000, while approximately 9.5% of claimants reported losing from $500,000 to $1 million. Approximately 13% of victims reported losses in excess of $1 million.

Mr. Breeden noted: “We have to eliminate ineligible or overstated claims before we can have an accurate picture of the losses. Nonetheless, it appears that at least twice as many investors as previously thought lost money in the Madoff fraud, with losses running many billions larger than previously documented. By far the greatest number of victims report that they have not recovered anything since the fraud. For many of those individuals, the forfeiture program can be a true lifeline.”

The wide dispersion of claims from around the world indicates that the Madoff fraud may be the most global fraud in history.

MVF received claims from victims in 119 countries or autonomous jurisdictions.
In 50 jurisdictions investors reported an average loss of more than $500,000 per claim.
In 28 jurisdictions investors reported an average net loss of more than $1 million per claim.
The largest number of claims from any one country came from residents of the United States, with roughly 58% of claimed losses. However, almost 62% of the persons filing claims reside outside the United States.
Victims in 24 countries reported a higher average loss per person than occurred in the United States.

The ten countries with the largest number of claimants were (in descending order):

United States
Germany
Italy
France
Switzerland
Austria
Spain
The Netherlands
United Kingdom
Taiwan.

Claims came from countries on every continent other than Antarctica. There were 26 countries or jurisdictions in which there were at least 100 claimants. In addition to the United States, Canada and Mexico in North America, MVF received claims in the Americas from Brazil, Argentina, Chile, Uruguay, Paraguay, Venezuela, Colombia, Peru, Ecuador, Bolivia, Guatemala, Panama, Costa Rica, El Salvador, Honduras, Nicaragua and Belize. MVF also received claims from numerous Caribbean states.

Eight of the ten countries with the largest number of claims were in Europe. However, there were claims from virtually every member state of the European Union. Claims also came from Russia, Kazakhstan and Georgia.

In the Asia/Pacific region, claims came from victims in China, Malaysia, Thailand, Singapore, Hong Kong, Taiwan, South Korea, the Philippines, Indonesia, Vietnam, Cambodia and both Australia and New Zealand. Claims also came from victims in India and Pakistan.

In the Middle East and Africa, claims came from victims in Kuwait, the United Arab Emirates, Qatar, Bahrain, Saudi Arabia, Oman, Lebanon, Turkey, South Africa, Kenya, Egypt, Zimbabwe, Zambia, Mozambique, Angola, Nigeria, Ghana, Senegal, Benin, Cote d’Ivoire, Liberia, Mauritius, Morocco, Algeria and Madagascar.

Locations that are often thought of as particularly low tax jurisdictions were also well represented. Claims came from such locations as Monaco, Gibraltar, Andorra, Lichtenstein, the Channel Islands, the Isle of Man, Cyprus, Malta, the British Virgin Islands, Bermuda, the Bahamas, Curacao and the Cayman Islands. Since many of these claims relate to persons who actually reside in other countries, our initial claims data per country may understate the number of victims in certain countries.

Many victims have not yet recovered anything

Mr. Breeden noted that more than 36,000 claimants reported to MVF that they have not received even $1.00 in recoveries from any source. “Tens of thousands of victims have not had any prior recovery for their losses, and for many of them, MVF is the only potential source of a recovery. We hope to make a meaningful difference for all victims, and especially for those who have not previously recovered any of their losses.”

Future Process

After all claims are reviewed, Mr. Breeden and MVF will recommend specific action on each claim to the Department of Justice, which makes all final decisions. The DOJ retains the discretion to amend its requirements or standards at any time, or to deny any claim that does not meet its criteria. The timing of distributions from MVF will be determined after claims are reviewed.

WE Family Offices Ranks Among Top 50 Wealth Managers In Forbes

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WE Family Offices was listed as a Top Wealth Manager in a national ranking produced by Forbes magazine based on WE’s more than $2.7 billion in total assets under advisement. New to the Forbes Top Wealth Manager list, WE, a leading family office, is also recognized as one of the one the fastest growing firms on the list.

“When, as a firm, you embrace transparency, clients appreciate that and it deepens those relationships.”

Founding partners Maria Elena Lagomasino, Santiago Ulloa and Michael Zeuner have dedicated their professional careers to advocating on behalf of wealthy families and helping them avoid harmful conflicts of interest. “We’ve realized that transparency and independent advice can often be difficult to find in the wealth management industry. We believe that families deserve to know who they can trust, and know that the advice they get is their best interests,” Lagomasino says. “When, as a firm, you embrace transparency, clients appreciate that and it deepens those relationships.”

“WE is hired by families to help them understand their whole picture, create their plan, and execute around that plan, day-to-day. WE ensures that a family has the right set of providers, at the right fee structure, working together to serve the family’s best interests,” Lagomasino continues.

WE stands for Wealth Enterprise. The company’s core beliefs and business practices are designed around the principle that great wealth should be managed like a business.

With offices in New York and Miami, WE Family Offices is a family-focused wealth management firm, catering to ultra-high net worth families. WE is not affiliated with any financial services company and is compensated only with client fees. As a result, WE’s advisors are free to offer their clients independent advice and serve as their advocate. WE’s services include: family advisory; investment strategy and oversight; and back office support. In 2013, WE Family Offices was ranked by Investment News as the number one RIA in Florida, by assets under advisement and, in 2014, was ranked among the Top 50 Wealth Managers in the U.S. by Forbes magazine.

Atlantic Policy Divergence

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Monetary policy in the US and in the eurozone is increasingly heading in different directions, with corresponding implications for fixed income markets. In truth, differences in monetary policy owe more to the stage in the economic cycle at which their respective economies are at – the eurozone arguably still in the recovery stage, some way behind the US which is in the mid-to-late cycle stage.

Divergence in eurozone and US 10-year yields

Source: Bloomberg, 10-year core government bond yields, US and eurozone, 02 May 2009 to 02 May 2014.

We expect that the US economy will continue to build momentum and that existing forward guidance will come under greater pressure this year. The first quarter gross domestic product growth figure of 0.1% (annualised) was disappointing but needs to be put into context. Unseasonably bad weather clearly hurt consumption, net exports are a notoriously volatile figure whilst the inventory build slowdown that negatively impacted first quarter figures augurs well for a rebuild over coming months. The second quarter, therefore, is likely to see a resumption of stronger growth data.

We are employing a number of strategies to take advantage of this divergence. This includes having exposure to interest rate risk in Europe

What is more, the jobs market is buoyant. Unemployment is dropping and associated wage pressure may not be far off. Vacancy rates, which are at high levels, suggest growing labour market tightness. Whilst inflation pressures are still muted, wage push inflation could be a concern and this will allow the market to consider interest rate hikes earlier and quicker than are currently priced in.

The US Federal Reserve (Fed) also appears committed to tapering its asset purchases (quantitative easing – QE) by an additional $10 billion at each Federal Open Market Committee (FOMC) meeting. If tapering is maintained at this pace, this would see additional QE end by the fourth quarter of this year.

In contrast, we have an outright short duration position in the US to mitigate the expected rise in yields

Assuming economic data remains robust, the Fed has suggested that rate hikes could come as early as six months after the current round of QE ends. Absent very weak data or another crisis, we therefore expect the first rise in interest rates to take place in the first half of 2015.

In contrast, eurozone growth is still anaemic and deflation remains a threat. The latest April flash Eurozone annual consumer price inflation rate came in at 0.7% versus 0.8% consensus. German inflation did not bounce back as strongly as expected and Spain is hovering close to outright deflation. This is helping to raise expectations of further policy easing measures such as negative deposit rates, revitalising the Asset Backed Securities market or QE.

We expect the euro to underperform the US dollar

Although the European Central Bank (ECB) has so far refrained from outright QE, Mario Draghi, the president of the ECB has been keen not to rule it out. Even Germany, which has been the most vocal opponent of QE, has softened its line somewhat. In late March, Bundesbank President Jens Weidmann stated that he could back QE under certain circumstances.

With this in mind we are employing a number of strategies to take advantage of this divergence. This includes having exposure to interest rate risk in Europe, which we believe will be rewarded given our view that eurozone monetary policy is unlikely to be tightened. In contrast, we have an outright short duration position in the US to mitigate the expected rise in yields, which would weigh on the prices of existing bonds.

In addition, we expect that shorter dated European government bonds will remain anchored, with the European yield curve remaining steeper than that of the US where we expect the yield curve to flatten as short dated yields rise faster than long dated yields.

Finally, we expect the euro to underperform the US dollar. This is because the euro has been relatively strong against the dollar recently but this relative strength is likely to be tested as US yields move higher and any rise in US interest rates draws closer.

Article by Kevin Adams, Director of Fixed Income at Henderson Global Investors

PwC US Signs 13-year Lease to Occupy New Office in Downtown Miami

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PwC US has announced that the firm has made a major commitment to the region by signing a 13-year lease with MetLife, Inc. for 43,277 square feet at the Wells Fargo Center in downtown Miami. Approximately 300 PwC partners and professionals will make their move into the Gold LEED-certified building located at 333 SE 2^nd Avenue in February 2015.

In addition to signaling its faith in an exciting and thriving part of downtown Miami, PwC sought out the building to accommodate its future growth plans. The professional services firm is optimistic about its long-term growth prospects in the market and intends to increase its employment in order to continue its strong growth trajectory in South Florida.

“PwC has a longstanding history of serving companies in the greater Miami area, and we’re looking forward to continuing that legacy,” said Mario de Armas, managing partner for PwC’s Florida market. “We continue to see an increased demand for our assurance, tax and consulting services, and we’re optimistic about our future employment and the growth of our business here. We also plan to continue our work in the community, with a focus on helping local schools and organizations improve education and financial literacy.”

The office will be equipped with state-of-the-art technology, including the latest media sharing and collaboration tools. De Armas noted that the layout of the new space will enhance team collaboration and knowledge sharing, cater to the mobile worker and aid in client service delivery.

“As our business and the businesses of our clients continue to evolve, we recognize that technology and the workforce of the future will change the way we work,” added de Armas. “The new office design reflects this, emphasizing teaming, personal flexibility and efficiency.”

The firm is committed to reducing its carbon footprint and will have the new space built with energy efficiency in mind. Sustainable materials and furnishings will be utilized throughout the space and PwC will strive for LEED certification when the build-out is complete.

“MetLife is excited to welcome such a high caliber firm as PwC to Wells Fargo Center. As one of MetLife’s premier developments and long-term investments, the Wells Fargo Center continues to attract many of the country’s most prominent companies,” stated Chuck Davis, Director and Head of the MetLife Southeast Regional Office.

The 47-story Wells Fargo Center features scenic views of Biscayne Bay and Miami‘s skyline and offers PwC a number of significant benefits, including a fitness center and restaurants. The center is also adjacent to a four-star hotel, which includes an entertainment complex, salon and spa, and shopping.

Natural-Resource Equities Could Provide Better Inflation Hedge than Commodities

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Foto: Kirainet, Flick, Creative Commons. Renta fija a corto a plazo, una solución para refugiarse de los tipos cero

Natural-resource equities could provide a better hedge against inflation than commodities themselves, according to a white paper from The Boston Company Asset Management, LLC (TBCAM), the Boston-based equity investment boutique of BNY Mellon.

This could be a particularly appropriate time to consider strategies that hedge against a rise in inflation as interest rates appear to have bottomed, the report said. It notes that an increase in the federal funds rate could come as early as the spring of 2015, which could spark a rise in inflation.

TBCAM warns that investors may wish to prepare for inflation despite concerns from the International Monetary Fund and U.S. Federal Reserve that inflation is too low. Such concerns may prompt central banks to add even more stimulus through quantitative easing and negative real rates, said Robin Wehbe, author of the report and portfolio manager for TBCAM.

“Preparing for the eventual transformation of stimulus into excess liquidity is paramount,” Wehbe said. The report, Inflation Investment Guide: The Advantage of Natural-Resource Equities Allocation, posits that natural-resource equities may provide inflation-hedging benefits without significantly reducing the performance of an investment portfolio in pre-inflationary time periods. Equities, natural resource equities and commodities perform differently across different inflation regimes, the report said.

“In times of low to moderate inflation, equities typically are the clear outperformer,” said Wehbe. “However, natural-resource equities have historically caught up and eventually overtaken the broader stock market to turn in the best returns as inflation begins to rise. Commodities tend to lag all equities in almost every inflationary environment, only outperforming the broad market in times of very high inflation.”

Rising U.S. interest rates contribute to a strengthening U.S. dollar and could drive inflationary pressures around the world, the report said. Countries with current account deficits will feel these pressures the most, according to TBCAM. The report notes that concerns about inflation have been blamed for the sell-off in emerging markets over the last year.

“It’s important to remember that commodities have an expected return of zero,” said Wehbe. “If you look at the historical return of commodities against other asset classes, such as equities, you’ll see that they have significantly underperformed.”

The report is available here.

The Major Headwinds Facing Brazilian Equities

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With elections looming in October, approval ratings for President Dilma Rousseff’s government have been touching new lows. At 36 per cent in March – down from 43 per cent at the end of 2013[1] – it is reaching a critical level. However, with an opposition lacking in substance, Rogerio Poppe, portfolio manager at BNY Mellon’s investment boutique, ARX Investimentos, explains why there is a high chance re-election could be achieved. What’s more, he says there’s a great risk of much-needed economic reform being dodged.

All is not rosy in Brazil. Inflation is high and vast swathes of the electorate feel out of touch and ignored. Much of Dilma’s focus during her time in office has been on social assistance through programmes such as Bolsa Família, a social welfare platform implemented by her predecessor, President Luiz Inácio Lula da Silva, which provides financial aid to poor Brazilian families.

While the success of Bolsa Família can’t be ignored – around 11 million Brazilian families benefit[2] – it has had its fair share of critics who cite the problems of benefit addiction and the programme acting as a source of discouragement from work. The programme may well help around a quarter of the population but for the remaining 75 per cent, the overriding concern is inflation and the rising cost of living in the country’s major cities. Some 85 per cent of the population lives in urban areas[3].

Meanwhile, there are significant public transport limitations and Brazil remains some way behind the rest of the world when it comes to infrastructure spending. According to The Economist, Brazil invests just 2.2 per cent of its GDP in infrastructure, well below the developing-world average of 5.1 per cent.

The global stage

The Brazilian people grabbed the attention of the developed world during last year’s Confederations Cup, the traditional pre-cursor to the soccer World Cup, as millions took to the streets of Brazil’s cities to demonstrate against the government’s failures.

“This year’s World Cup is likely to prompt further unrest but we don’t expect it to be on the same scale as 2013,” said Poppe, who runs the BNY Mellon Brazil Equity Fund.

“Last year’s troubles were caused by a minority; peaceful protest had been the general intention.”

“What’s more, let’s not forget that this is Brazil and the World Cup we are talking about – never underestimate the draw and importance of football to the Brazilian psyche. Righting the wrongs of 1950 – the last time Brazil hosted the World Cup it lost the final to Uruguay – will do much to preoccupy the electorate,” he added.

Regardless of the widespread protests, Dilma has done little, if anything, to address the underlying concerns of the Brazilian people, according to Poppe; indeed, inflation continues to exasperate these problems.

“The effects of inflation will only get worse as areas in which the government has frozen prices, such as fuel, are unfrozen,” he explained.

“At the same time, fuel price freezes have severely hampered the ability of largely state-owned companies, such as Petrobras, to thrive. That the weakness in her approval ratings has corresponded with strength in the domestic stock market is no coincidence.”

“Dilma’s administration has limited the value of these companies by using them as a political lever. It is a similar story with the state-owned banks; used as a tool for cheaper credit availability, there is a need for significant capital raising within the banking system over the next five years.”

A period of sustained economic stagnation is the likely result, he says.

Challenged challengers

But what of the opposition to Dilma’s Workers’ Party?

“This is the crux of the problem – there is little opposition of substance,” said Poppe.

The major opposition party, the Party of Brazilian Social Democracy (PSDB), is yet to announce its candidate to run against Dilma. Aécio Neves is widely expected to be PSDB’s ‘man’ but uncertainty prevails.

What’s more, the party has long been dogged by internal wrangling and has also recently been the subject of an investigation into alleged corruption in the São Paulo state government, which it has run since the mid-1990s.

“Uncertainty abounds when it comes to the major opposition’s policies, too; inflation aside, there has been little detail forthcoming,” Poppe added.

A change of government seems a long shot but, at the very least, Brazil needs a change in government. Poppe says this seems unlikely, however.

“We believe Dilma’s re-election would be a negative for the Brazilian economy over the next decade,” he warned.

“The economic fundamentals are still very good, despite the recent Standard and Poor’s downgrade; indeed, the country is in ruder health than many European economies. Yet the problem remains the direction taken by the incumbent government – the current economic policy is a limiter on growth.”

“Ultimately, Brazil needs to follow the trail blazed by Mexico and implement far-reaching and achievable reforms. Given the scale of the Brazilian market, it too should be attracting huge investment – sadly, though, this is no longer the case.”

A Dilma re-election would usher in no change, according to Poppe.

“She vehemently believes in what she is doing – she is a lady not for turning.”

The result? An economy saddled with inflation, a depreciating currency, an inability to attract external investment and the prospect of low growth over the coming years.

Latin America’s great hope is facing a tough near-term future. Seleção glory this summer might prompt a short-term bounce but once the celebrations die down, the bleak reality will be felt once again.

[1]National Industry Confederation, March 2014

[2]The World Bank, April 2014

[3]The World Bank, December 2013