Brazil: Untapped pools

Foreign investment in Brazil has been an important driver of the country’s resurgent private equity industry over the last few years. Unfortunately for international fund managers, the flow of capital has been decidedly one way. According to sources, that may be about to change.

Maureen Downey, a principal at fund of funds Pantheon, believes that Brazil’s giant pension funds could branch out into international private equity investments within the next 18 to 24 months. “Some of the pension funds have noted to me that they could be making international commitments as early as the second half of next year,” she told Private Equity International. “Their alternative asset allocation is increasing, and they [are playing] an important role in the development of the local private equity market.”

Brazilian pensions managed over $342 billion in assets as of 2010, according to consulting firm Towers Watson. Typically, they have invested most of their assets in fixed income. But with interest rates falling – after peaking at 21 percent in 2002, they were cut to 11.5 percent this year (despite inflation hitting a six-year high) – alternatives are starting to look increasingly attractive.

“One of the main things that’s going to drive them to do more alternatives is this lowering of the interest rate,” says Downey. “When I sit down and talk to Brazilian pension funds, they say: ‘You know, I get 6 percent now, but it’s going to 5.5 percent, and I must obtain a 6 percent return to meet my liabilities’. It will be challenging to achieve that target rate of return through fixed income investing alone – and they know it.” 

I get 6 percent now, but it's going to 5.5 percent, and I must obtain a 6 percent return to meet my liabilities

Maureen Downey

On the face of it, that sounds like good news for international fund managers battling to raise money in a tough fundraising market. Existing limited partners in the US and Europe are placing ever-greater demands on GPs, and are hesitant to embark on new relationships; in a recent report, placement agent Triago projected that market trends could force up to one-half of all GPs from the market in the next five years as limited partners consolidate their private equity holdings with fewer managers. So a brand new $342 billion pool of capital has a lot to be said for it. 

However, fundraising in a new market is never simple. At a Dow Jones conference held earlier this year, Blackstone Group senior managing director Michael Sothiros and Pantheon director Kevin Albert indicated that when the Brazilian pensions do take the plunge into international private equity investing, it will probably be through a structure similar to Chile’s. There, managers are required to establish feeder funds through local financial firms, which can then direct commitments from the country’s public pensions to foreign private equity funds. 

The strategy has already been implemented by The Blackstone Group, which is working with a brokerage firm called Larrain Vial to market its sixth fund, said Sothiros. Larrain has been raising a $700 million fund called Larrain Vial-BCP VI, according to documents filed with Chilean ratings agency Feller Rate.

A transition towards a Chile-like system would be a natural progression of the Brazilian pensions’ investment strategy, sources say. 

But US and European GPs probably shouldn’t get too excited about the prospect of receiving big commitments from pensions in Rio De Janeiro or Sao Paolo any time soon.

“I would find it very surprising,” says Russell Deakin of Brazil-based asset manager Rio Bravo. “They have such small allocations to private equity as an asset class. To go abroad, when frankly the returns in international private equity funds I think are challenging given this environment… [The pensions] have the whole Brazilian universe to explore.”

[The pensions] have the whole Brazilian universe to explore

Russel Deakin

In other words, rather than betting on US and European private equity funds, which are facing tepid growth rates in their home markets, Brazilian LPs might be better off increasing their allocations to alternatives through local funds – which are also likely to be more accommodating of the pensions’ tendency to request seats on investment committees.

Then there are the practicalities to consider. According to Downey, although a Chilean structure in Brazil would at least give international GPs a foot in the door, only a handful would have the in-house capacity to jump through the legal and regulatory hoops of establishing a feeder fund. “It’s going to be the larger firms that have the resources, the bandwidth to go down there.”

Equally, the top performers probably won’t bother, since they can achieve their fundraising targets anyway. As Downey points out: “If they do have to go down there to raise a small fund … you’re going to have to scratch your head and query: why? Why haven’t they been able to raise enough money in their own home market?”