Root Capital — a credit manager with R$ 4 billion in assets — believes that the opportunities for good returns in liquid securities are close to zero, with the compression of spreads in recent months emptying the return on these assets.
On the other hand, opportunities are still abundant in longer-duration duration securities.
“For funds with D+0 or D+1 redemption, there are hardly any opportunities today; everything is very expensive and reaching dangerous levels,” Root’s manager Rafael Fritsch told Brazil Journal.
“At D+60, some opportunities start to arise, as it’s possible to have shares of senior FIDC and more structured operations. But it’s at D+180 where there is more premium today, as these funds are facing negative inflows, leading to limited resources available for operations.”
In its latest monthly letter, Root notes that net inflows of credit funds reached R$ 115.6 billion in the third quarter — concentrated in highly liquid funds — leading to a compression of spreads in the secondary market.
According to the manager, spreads have reached the lowest level in the past 24 months, both in CDI-indexed securities and IPCA-indexed securities. In September, secondary market spreads reached 186 basis points over CDI and 36 bps over NTN-B.
Continuing a downward trend since last year, “the securities that make up the Anbima Debentures Index reached a spread of 1.38% by the end of the third quarter, after reaching 1.53% in the second quarter and 2% at the end of last year,” Root stated in its letter.
The primary market has also remained active, with a record R$ 111.6 billion in new issuances in July and another R$ 108 billion in August, with a significant portion of the issuances coming from companies taking advantage of the compression of spreads to perform liability management (essentially, swapping expensive debt for cheaper debt).
Root is concerned that this market expansion is happening at a time when the number of judicial recoveries is increasing in Brazil, with this year’s cases on track to surpass the numbers seen in 2016, following the Dilma government crisis.
“It’s a very complicated time for credit because, contrary to expectations, interest rates have increased, making it difficult for companies to meet their payments,” Fritsch said.
He believes this should affect the pricing of issuances, leading to an increase in spreads. “But at the moment, what prevails is the flow,” he added. “However, at some point this flow will slow down, spreads will no longer close, and the yields of these funds will decrease.”
To take advantage of this scenario, Root is raising a new special situations fund that will purchase bonds from struggling companies, court claims, and legal claims. The goal is to raise R$ 500 million for a closed fund with a six-year term.
“Currently, there is a significant liquidity premium in the market. So, you have to avoid the obvious and go where there are true opportunities,” he said.
The letter also discusses what Root refers to as ‘super-diversification’ — a practice becoming common among credit managers, which may prove more harmful than beneficial.
Root has found credit funds with allocations in “a hundred, two hundred, three hundred securities, where many issuers have tiny stakes in the portfolio, often less than 0.10% of net worth.”
“Some portfolios have become true ETFs of private credit, where active management is greatly restricted and the ability to generate alpha is limited,” the letter states.
Root mentions that, unlike the stock market, where potential losses can be offset by significant gains in other assets, this does not happen in the credit market.
“We believe that there is an optimal level of portfolio diversification in credit, beyond which the inclusion of a new asset works to worsen the portfolio returns rather than improving its risk profile,” the letter concludes.
“In our view, active credit management should be conservative by nature and avoid situations that may lead to defaults, as these are not easily recoverable, especially in our country, where recovery value of assets is low, the process is lengthy, and the opportunity cost is high.”
Source
Arwen Volkov, A graduate of the University of St. Gallen in Switzerland with a degree in International Finance, Arwen specializes in sustainable finance and green investments. She began her career at an investment bank in London, where she developed financing models for environmentally friendly projects. Known for her analytical and strategic thinking skills, Arwen is a sought-after financial consultant. In her spare time, she mentors fintech startups, contributing to their growth strategies. She is also a nature enthusiast and an amateur photographer.
