A $4.6 Billion Brazil Fund Bets Inflation Will Slow Down and Petrobras Will Rebound

Kapitalo Investimentos Ltda, one of Brazil’s largest hedge fund managers, is on the lookout for mispriced risk at home ahead of general elections

Petrobras has been under heavy political pressure to reduce fuel costs to help bring down annual inflation running near 12%.
By Vinícius Andrade and Rachel Gamarski
July 18, 2022 | 04:44 PM
Reading time: 2 min.

Bloomberg — Kapitalo Investimentos Ltda, one of Brazil’s largest hedge fund managers, is on the lookout for mispriced risk at home ahead of general elections.

The firm, which manages about 25 billion reais ($4.6 billion), is wagering that inflation rates implied in the bond market will slow and that investors have become too negative on state-controlled oil company Petroleo Brasileiro SA. (PETR3, PETR4)

Petrobras share prices reflect bets on a “terrible scenario” after October’s presidential vote, so any outcome that’s marginally better could bring gains, Carlos Woelz, the firm’s co-founder, said last week in an interview in Sao Paulo.

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“That’s a place where we like to be: where all of the negatives seem to be in the price,” said Woelz.

Petrobras has been under heavy political pressure to reduce fuel costs to help bring down annual inflation running near 12%. The spat has led to a revolving door at the oil giant -- there’s been four chief executive officers this year -- but the noise has failed to alter its policy of aligning domestic fuel prices to the international market.

Shares of Latin America’s largest oil are little changed this year, trading at 1.9 times enterprise value to forward earnings. That’s less than half the 4.5 multiple for US oil giant Exxon Mobil Corp. and below Argentina’s state-run oil company YPF SA, according to data compiled by Bloomberg.

In Brazil’s fixed-income market, Woelz thinks investors are overestimating inflation and is taking positions that will profit when those expectations come down. Five-year breakevens -- the inflation rate implied by prices in the bond market -- reached 7.58% last month, the highest since 2016. Premiums look “attractive” and Woelz has been targeting positions in bonds expiring in up to five years.

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“Either we’ll see a sharper economic slowdown than what policy makers are expecting or the central bank will keep a tight monetary policy for longer,” he said. “Brazil’s central bank is committed to making inflation converge to the target.”

Kapitalo’s Zeta fund was among local hedge funds that profited from anticipating an interest-rate surge across global markets, including the US. Right now, Woelz has smaller positions that gain from higher rates in some emerging markets.

The red-hot US inflation data last week reinforced the view that the global economy won’t avoid a recession, according to the money manager. Woelz expects the Federal Reserve to fall short from delivering a full percentage point hike at its next meeting, but says the tightening cycle will probably be longer.

In Brazil, Woelz says that conditions for an easing cycle to start around mid-2023 are different from the ones the country saw before the 2016 rate cuts started. The output gap is now smaller, while jobs data have been coming in stronger than the levels seen six years ago. That means the central bank will likely need to revise its forecast for 2024 inflation, which currently sits at 2.7%, higher.

Bruno Cordeiro, a partner and portfolio manager at the firm’s K10 fund, said investors are bracing for an increase in Brazil’s public spending regardless of who the next president is. Under former President Luiz Inacio Lula da Silva or incumbent Jair Bolsonaro, the key question will be how the government will fund higher expenses, said Cordeiro, whose fund outperformed 93% of its 198 peers in the past year, with a 20% gain.

Kapitalo was founded by Woelz and Joao Carlos Pinho in 2009, and currently has a team of about 110 people.