Understand when a dollar bond should have an interest rate higher than that referenced to the IPCA – 05/27/2023 – From Grain to Grain

Lost with the great diversity of assets abroad, Brazilian investors usually prefer securities of Brazilian companies when investing internationally. The knowledge of Brazilian companies brings a perception of lower risk.

However, care must be taken with the rate of return acquired, as it may be more advantageous to buy the same security in Reais. I explain below how to compare interest rates abroad and in Brazil.

Before I explain, I’ll pose a question. Consider two bonds from the same company, with the same maturity and cash flow schedule. Which one would you prefer?
1 – Dollar bond at 6% per annum;
2 – Fixed income security at IPCA+6.5% pa;

I’ve seen many investors prefer to invest in Brazilian bank securities abroad at 6% per year in dollars than to invest in CDBs from the same issuer at IPCA+6.5% per year. The preference is even more incoherent, when we consider that the CDB is guaranteed by the FGC up to R$ 250 thousand, while the title abroad has no guarantee.

Anyone who thinks that Brazilian company bonds in dollars should have a lower interest rate is wrong. It is because of this thinking that many Brazilian investors end up paying dearly or settling for lower returns.

To estimate the interest rate that you would be indifferent between investing in the local or international market, you need to make two estimates. It will be necessary to estimate the appreciation of the dollar and the IPCA over the next few years.

One way to make this estimate is to assume that what happened in each year of the past 20 years is just as likely to happen again. Making this assumption, each year would have a probability of 1/20 of repeating itself. Thus, the expected return for the coming years is simply the arithmetic mean of the annual variations of the last 20 years.

For the Real/Dollar exchange rate, the arithmetic average of returns over the last two decades was 4.2% per year of Dollar appreciation. For the IPCA, the average variation was 5.7% per year.

If we consider these assumptions for Dollars and the IPCA, if you have a security from a Brazilian company trading at IPCA+6.5% per annum, you should only prefer a security in Dollars from this same company with a rate greater than 8.1% per annum .

For this comparison, it is important that the two bonds have the same characteristics, for example, maturity and schedule of interest and amortization payments.

The bond with an interest rate of 8% in Dollar should yield 12.6% in Reais. The account is simple. Just add 1 to the rates, then multiply and then subtract 1, that is (1+4.2%)*(1+8.1%)-1.

It is possible to make the same calculation with the title referenced to the IPCA: (1+5.7%)*(1+6.5%)-1 = 12.6% per year.

Therefore, before investing in securities of Brazilian companies abroad, compare interest rates using the calculation above. In this way, you will be able to properly choose the title with the best yield to invest your assets.

Michael Viriato is an investment advisor and founding partner of Investor House.

Talk directly to me via email.

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