(Bloomberg) -- Brazil has learned its lesson. At least for the next decade.
That’s the bet Squadra Investimentos is making as it scoops up shares of state-controlled companies that its fund managers say will benefit from a shift to market-friendly policies. The rally in Brazilian stocks is just beginning, and gains are set to accelerate after October elections give investors clarity, partner Guilherme Ache said at his office in Rio de Janeiro’s swanky Leblon neighborhood, where he helps oversee 7 billion reais ($2.2 billion) of assets.
Brazil is home to the world’s best performing major stock market this year as economic growth picks up, extending a rebound that began in early 2016 as investors bet on a political transition after 13 years of rule by the leftist Workers Party. State-controlled companies had suffered from price controls, ballooning debt and politicized management. Since taking power 22 months ago, President Michel Temer has sought to promote investment, announced privatizations and taken steps to make the oil industry more competitive.
“Even if the next president isn’t a market darling, he will move in the same direction,” said Ache, who previously managed funds at JGP Gestao de Recursos and was head of research at BTG Pactual. “It’s either reforms or abyss.”
Squadra started adding to positions in oil producer Petroleo Brasileiro SA and power company Centrais Eletricas Brasileiras SA in mid-2017 along with other firms either poised to be privatized or sell assets, Ache said. Petrobras has surged 75 percent since the end of the second quarter, while Eletrobras is up 65 percent in that span.
Volatility is to be expected in the run-up to October elections, but the Ibovespa stock gauge -- which has doubled since January 2016 -- is just starting a positive trend that will last for years, Ache said. There is a broad consensus among political parties to shore up government finances that will continue into the next administration no matter who wins. A pension overhaul is needed to cut a ballooning fiscal deficit, rising debt levels and bloated state payrolls that have cost Brazil its investment-grade credit rating.
The state-controlled companies that suffered the most during Brazil’s downturn offer the biggest upside now that the cycle has turned, according to Ache.
Petrobras is benefiting from market-based fuel prices, a massive divestment program that is curbing expenditures and reducing leverage, and production growth that could reach 15 percent next year, an “unprecedented” rate among global oil majors, Ache said.
Squadra also owns stakes in power generator Cia. Energetica de Sao Paulo, or Cesp, and BR Distribuidora, the Petrobras fuel unit that was spun off last year in an initial public offering. Both Cesp and Eletrobras are expected to be privatized as early as this year.
The Squadra Master Long Only FI Acoes fund has returned 15 percent this year and 6.4 percent in the past month, beating about 90 percent of comparable peers in those periods, according to data compiled by Bloomberg.
The fund, which only invests in Brazilian assets, is more cautious about financial shares that are “overpriced” and poised to underperform in the future. Squadra sees growing competition from fintech firms, lower interest rates, and smaller profits from trading.
Still, the wider outlook is rosy for Brazilian equities. The market is still small compared with the size of the economy, and valuations will surge when domestic retail investors start shifting into the stock market amid lower interest rates, according to the hedge fund.
“The big challenge for portfolio managers is to hold and buy expensive, because it will get more expensive,” Ache said.
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