The party is over: LPs consider dumping Brazil funds

Brazil was the focus of a fundraising frenzy over the last few years, with big developed-market limited partners pouring billions into managers with international reach.

But that fundraising bull market may turn into a fund-selling boom as LPs consider the possibility of dumping their interests in Brazil funds at steep discounts.

The decision to sell is based on the belief that the Brazilian economy is not likely to make a recovery any time soon, and the best course of action is simply to cut and run, two secondary market sources said in recent interviews.

“We’re now seeing western investors who are capitulating, saying, ‘Hell with this,’” said one of the sources, a buyer in the secondary market who works with emerging-markets funds. The thinking is, “The upside is we get our money back, the downside is we lose everything. I’d rather sell at 50 cents [on the dollar] and call it a day,” the secondary buyer said.

It’s not clear who is selling, or whether Brazil funds are starting to flood the secondary market. In fact, four other sources familiar with the secondary market said they have not seen any appreciable increase in the number of Brazil fund stakes being offered. What they have seen is Brazil-focused funds included in larger portfolios of private equity funds.

Another source, a fund-of-funds manager focused on the region, said Brazil sellers on the market have been domestic Brazilian pensions. Those domestic pensions are selling because of the macro situation in the country, but also because their bets in local managers have not paid off, the FoF manager said. Also, some of these institutions are facing denominator effects in their portfolios, where the value of the public equities portion declines, driving up the value of the private investment portfolio beyond allocation caps.

“Local pension funds are getting out because it’s not worth it,” the FoF manager said.

However, selling now seems like desperation and doesn’t make a lot of sense, said a secondary market intermediary. Why not hold the funds through their investment periods and see what happens with the macro situation?

Bull market

Latin American funds raised $10.39 billion in 2014, beating the previous record of $10.27 billion 2011, according to the Latin American Private Equity & Venture Capital Association. Brazil funds collected $5.56 billion across 23 partial or final closings in 2014, LAVCA said.

Fundraising included vehicles raised by large, pan-regional firms collecting money from LPs around the world, as well as domestic GPs raising money from local LPs. Local pensions in Brazil have helped seed a domestic private equity industry by backing homegrown GPs. Those domestic pensions generally don’t invest in international private equity because they require a seat on the investment committee, which international GPs don’t allow.

The problem in Brazil is that even funds that are performing well are taking a hit from currency devaluation, with one Brazilian real worth about 24 cents.

Many of the biggest Brazil funds of the past few years were raised in U.S. dollars. These funds call capital in U.S. dollars and convert to reais to make investments, according to Andrea Minardi, professor at Insper Institute of Education and Research, writing for the Emerging Markets Private Equity Association. Upon exit, firms receive proceeds in reais and convert them back into U.S. dollars, which means they take a hit on the currency spread, Minardi wrote.

“As performance and profits are measured in dollars, and as the investments are in reais, funds run currency risk,” she wrote.

One firm whose funds have shown up on the secondary market is BTG Pactual, sources said. BTG Pactual raised $1.5 billion for its first fund in 2011, and was targeting $1.5 billion for its second fund starting in 2013. It’s not clear how much Fund II raised.

BTG Pactual is a special case, however, as the firm is in “fire sale” mode after the arrest of its Chairman and Chief Executive Officer Andre Esteves in November as part of a corruption probe at national oil giant Petrobras.

“They’re selling assets as quickly as they can,” the fund-of-funds manager said.

BTG Pactual didn’t respond to a question sent to its investor relations email address.

Action Item: Read about currency impacts on Brazilian private equity funds here: http://bit.ly/1QwBLoG

Photo: Revellers from the Leandro de Itaquera samba school take part in the first night of the Special Group of the annual Carnival parade in Sao Paulo’s Sambadrome February 28, 2014. REUTERS/Paulo Whitaker