As a Benchmark Loses Prominence, Brazil Seeks Alternatives

The following is an excerpt from an article in:


The New York Times
Friday, October 26, 2012

As a Benchmark Loses Prominence, Brazil Seeks Alternatives

By DAN HORCH

SÃO PAULO, Brazil - Investment benchmarks are meant to be stable, authoritative guideposts for sizing up assets and performance.

But as the recent scandal involving the London interbank offered rate, or Libor, has shown, traditional benchmarks can come under attack. Even ones that have proved reliable may become obsolete, especially in a rapidly changing emerging market.

In Brazil, a system that has been in place for decades may soon change and force fund managers to dive into riskier investments in order to meet performance goals.

Since the 1980s, most Brazilian asset managers have shaped portfolios, measured performance and assigned bonuses based on a single benchmark: Brazil's interbank deposit certificate rate, known in Portuguese as the Certificado de Depósito Interbancário, or C.D.I.

Because of Brazil's history of high inflation and high government debt, common global benchmarks for fund performance were for many years not relevant.

To attract wary investors, the government had to issue bonds whose yields automatically changed with the Central Bank of Brazil's basic interest rate, ensuring attractive returns even after inflation. Both giant pension funds and individual retirees bought these bonds en masse.

To reflect this reality, in the 1980s the financial industry created the C.D.I. rate, a daily average of overnight interbank loans, which hovers close to the central bank's basic interest rate.

The C.D.I.'s influence extends throughout the economy, where many other interest rates rise and fall with it on a daily basis. Bank certificates of deposit pay a percentage of the C.D.I., corporate debt pays a percentage of the C.D.I. or the C.D.I. plus a spread, and most of Brazil's asset management industry uses it as its benchmark.

Currently, fixed-income and all-asset funds aim to beat the C.D.I., sometimes called the D.I. rate.

Aggressive hedge funds that leverage up and invest primarily in equity, corporate debt, currencies and derivatives take their 20 percent cut not on absolute profits, but on performance that exceeds the C.D.I.

But in the last decade, Brazil has become a rising power. Gone are the days of high inflation, and budget deficits are far lower than in most of the developed world. The country is now the world's sixth-largest economy.

As a result, it no longer makes sense to invest with a focus on loans with a duration of a single day, but most fund managers' mandates still require them to do just that.

For more, visit www.nytimes.com.