Brazil again becomes hotspot for pension funds

RIO DE JANEIRO — Private equity fund managers in Brazil, after a rocky start, once again are attracting U.S. and European pension fund investors.

Brazilian private equity funds — and Latin American funds private equity funds with a focus on Brazil — raised $5.2 billion in 2007, compared with $2.8 billion in 2006 and $1 billion in 2005, according to private equity manager Advent International. Some 90% of the money raised last year was from foreign investors, 60% of which was from U.S. and European pension funds.

Foreign private equity managers in Brazil did not fare well with their first-generation funds. Many that started in the mid-1990s stumbled because of the January 1999 currency crisis, which triggered a major devaluation of the Brazilian real, along with the lack of corporate governance and investor protection and a stagnant economy from 2001 to 2003.

But since 2004, Brazil's economy has grown an average of 4.5% a year, with the gross national product reaching 5.4% in 2007 and expected to hit 4.8% this year, according to the International Monetary Fund, Washington.

Estimates for U.S and European Union growth this year, in comparison, are 0.5% and 1.3%, respectively. And on April 30, Standard & Poor's upgraded Brazil to an “investment grade” rating, a long-awaited sign of foreign investors' increased confidence in the country's economic soundness that should lead to increased foreign investment flow.

Brazil's brighter economic picture, a strong currency and private equity managers' better knowledge of the market have led to new funds being created.

“Now that Brazil's economy is strong, especially in relation to the United States and Europe, new Brazilian PE funds they have recently created are getting more investments from U.S. and European pension funds wanting to boost their returns,” said Roger Leeds, chairman of the Emerging Markets Private Equity Association, Washington, in an interview. “Although those investments account for only a small percentage of these pension funds' portfolios in alternative assets ... they are on the rise.”

Said Patrice Etlin, a partner in the Brazilian office of Advent International, in an interview: “I expect U.S. and European pension fund investments in PE funds focused on Brazil ... to increase in the next few years because this country's economy is strong, because a U.S. recession will force them to diversity into PE funds in Brazil and other emerging markets to get better returns, and because Brazil's strong capital markets provide sound IPO exit strategies.”

Advent's Latin American private equity funds have, in the past 12 years, raised $2.2 billion, 50% of it from U.S. and European pension funds.

Steve Guterman, senior managing director for business development at AIG Investments in New York, agreed that U.S. and European interest in Brazilian private equity funds is rising. “One year ago, when it became evident that the world was in a commodities boom and Brazil, with a stable and booming economy, would be a big beneficiary, pension fund comfort levels about investing in Brazil increased dramatically and should continue to do so,” he said in an interview. “In addition, valuation levels of Brazilian companies were attractive in global comparative terms, and are expected to stay attractive.”

Mr. Leeds told participants at a conference sponsored by The Brazilian Association of Private Equity and Venture Capital held last month in Rio de Janeiro that emerging market private equity funds have been outperforming U.S. funds. As of Sept. 30, the latest statistics available, U.S. private equity funds produced 30% one-year returns and 24% three-year returns, while Latin American private equity funds returned 35% on a one-year basis and 30% over three years, he said, citing figures from Cambridge Associates LLC, Boston.

About 75% of the Brazilian private equity deal flow involved fund managers buying minority stakes in small to midsize companies. The vast majority of deals involve private firms, and about 25% are through buyouts, according to managers.

Advent's Latin American private equity funds have taken both minority and majority stakes in companies. But Mr. Etlin told conference participants that the greatest private equity lesson he learned in Brazil was “never buy a minority stake because, as 96% of the PE investments in Brazil are in family-owned businesses, you can never take a driver's seat and change management.”

AIG Investments has raised nearly $1 billion in Brazilian private equity funds since 2000, and has invested more than $300 million of it, all in significant minority stakes in 15 firms. Around 20% to 30% of that $1 billion came from non-Brazilian pension funds, many of them American.

“In a high growth market like Brazil, we prefer investing in businesses which need expansion (rather) than buying control of one that could be broken and take years to fix,” said Mr. Guterman in the interview. “We also don't like paying the high control premiums for Brazilian firms.”

Marcos Rechtman, head of private equity in Brazil for Banif SGPS SA, an investment bank based in Funchal, Portugal, said the Brazilian private equity fund that Banif is raising will buy minority stakes for the same reason.

“In Brazil, buyouts come with such high control premiums that most PE fund managers prefer influential minority positions, say as part of the control group, ones in which they can help manage conflict and company restructuring,” he said.

Banif is now trying to raise $1 billion from pension funds — 80% of which are in the United States and Europe — for its first Brazilian private equity fund. The fund plans to invest in water/sewage treatment plants, transportation infrastructure and commercial storage real estate such as grain silos and industrial warehouses.

“We think U.S. and European pension funds will want to invest in our PE fund because the Brazilian economy is expected to grow 18% in the next three years, far more than in their countries and because Brazilian business and industrial sectors are still consolidating, and their increased economy of scale will boost their value and their returns,” said Mr. Rechtman.

Patria Investimentos, a private equity fund manager in Sao Paulo that since 1997 has raised $1.2 billion for three Brazilian private equity funds, mostly buys control stakes in local companies. Around 60% of the funds' capital is foreign, and 20% of it comes from U.S. and European pension funds and endowments, said André Penalva, a Patria partner.

“U.S. and European pension funds who started investing in PE funds here in the last few years, should start to sink even more into them and less into PE funds in their own countries because Brazil's economy is growing faster than their economies,” said Mr. Penalva. “And that means bigger returns.”