Previ: How high interest rates put profitability before diversification

Previ, the $48 billion pension fund for Banco de Brasil employees, has a tiny fraction of its portfolio invested outside Brazil. Despite repeated efforts to diversify, Brazil’s oldest pension fund, founded in 1904, currently ploughs all but 0.5 per cent of its portfolio into Brazilian assets, namely government and corporate bonds, and domestic equity.

Claudio Goncalves, who is about to press the button on new, externally run active allocations to US equity, is the latest CIO at the fund determined to invest more overseas.

“Having so much invested in the Brazilian economy is insanity in my opinion,” says Goncalves in an interview with Top1000funds.com.

The bulk of Previ’s portfolio is split between two main funds. A R$240 billion ($41 billion) defined benefit plan, closed to new entrants back in 1990, is run on an LDI strategy where most of the assets are invested in fixed income, particularly inflation-linked bonds which comfortably meet the fund’s actuarial return of inflation +4.75 per cent. This plan’s legacy allocations to real estate and equities will continue to be steadily reduced over time, says Goncalves.

The second largest portfolio, Previ Futuro, amounts to around R$35 billion of defined contribution assets. Set up in 1998, it runs eight different strategies according to beneficiaries’ risk appetite and target date options, and is where Goncalves wants to focus his overseas diversification efforts.

Not only has Previ missed out on much of the gains derived from investing in AI and the tech boom that has fuelled the US stock market and pension fund returns the world over, the fact that local companies only make up 5 per cent of the MSCI Emerging Markets index signposts the cap on domestic equity returns and investing so much in Brazil has also meant the fund hasn’t reaped other diversification benefits like volatility and exchange rate differentials.

New US President Donald Trump has also exposed the dangers of a Brazil-focused strategy and made the argument to invest more overseas even more compelling. Apart from threatening tariffs on Mexico, most of Trump’s attention on Latin America (at the time of writing) has been around immigration. If he were to slap tariffs on Brazil, Goncalves believes it could have a profound impact on fiscal policy, impacting the stock market, volatility, the exchange rate and high interest rates on which the pension fund depends.

“There is a new variable called Donald Trump, and his relationship with South America is still a big question mark,” says Goncalves.

The pull of home

The lack of progress on overseas diversification is not due to regulation. Previ is free to invest a maximum of 10 per cent of the portfolio outside Brazil.

Goncalves believes the pandemic stalled progress in meeting new targets set out by his predecessor Marcelo Otavio Wagner to allocate 2-3 per cent of assets under management to overseas markets by 2022 and 10 per cent by today.

The real reason is the opportunity cost. Every time Previ prepares to take a bold move to diversify, it is thwarted by Brazil’s high interest rates which make it much easier to tap returns at home and put profitability before diversification.

Interest rates in Brazil currently sit at 13.25 per cent and some economists predict they will spike to 15 per cent by the end of 2025. Meanwhile, sovereign inflation-linked bonds (NTN-B) pay inflation plus 7 per cent and offer compelling tenors out to 2060.

“Brazil is well known as a country with very high interest rates, and we take advantage of this. You can’t ignore an interest rate of 13.25 per cent or inflation linked bonds paying inflation plus 7 per cent,” says Goncalves. The returns derived from high interest rates also speak for themselves. In 2023, Previ Futuro easily outperformed its 8.5 per cent target, returning 16.1 per cent and all eight investment profiles exceeded the benchmark index in 2023.

Still, Goncalves is determined to green light new overseas allocations and has whittled down the number of external managers to seven, of which five or six will be approved. His primary focus is on gaining exposure to US equity. Although some of the managers have expertise in Europe and Asia, he is concerned about weak European growth prospects and unknowns in the Chinese and Indian markets.

“We are trying to measure how much we will invest abroad. We are pretty much there,” he says.

It’s also a question of timing. Market volatility triggered by DeepSeek threatening US dominance in AI and Trump’s threat of tariffs has given the team pause in recent days. Goncalves is also monitoring the impact on the exchange rate between the real and US dollar – forecasts that the US dollar would get stronger have proved wrong as the real continues to experience the longest streak of gains in 20 years.

“We are trying to understand what is going on,” he concludes.