Arthur P. Steinmetz, manager of the best-performing international bond fund in the United States, is buying more Brazilian debt during what he calls the country's "golden age."
The $6.4 billion Oppenheimer International Bond Fund has 6.7 percent of its assets in Brazil for the second-biggest stake after the United States. The Brazilian real's 74 percent increase since 2003 propelled Steinmetz's fund to average annual returns of 14.6 percent in the last five years, the most among 10 competing mutual funds that buy debt globally, according to data compiled by Bloomberg.
President Luiz Inacio Lula da Silva's central bankers have cut interest rates to a record low of 12.50 percent as annual inflation has slowed to about 3 percent through mid-April. The Brazilian bond rally will continue as the gap between official interest rates and inflation narrows, Steinmetz said.
"Right now is the golden age of bond investing in Brazil," Steinmetz, 48, said in an interview from his office at OppenheimerFunds Inc., of New York. "If you disagree with my thesis, stay away from this fund."
Brazil's is the only emerging economy in Steinmetz's top-five country allocation. His stake, which rose from 5.8 percent in June, includes corporate and government debt as well as structured securities issued by investment banks.
The Oppenheimer fund has returned 4.9 percent this year, placing first among its peers. The Federated International High Income Fund is ranked No. 2, rising 3.9 percent this year and an average of 13.5 percent in the last five years. The Federated fund has 19.4 percent of its assets in Brazil, although only 2.6 percent of the fund is in real-denominated securities.
Most of the Brazilian debt in the International Bond Fund is denominated in reais, meaning investors in those securities benefit from the currency's advance against the dollar. The real has risen more than any other currency against the dollar since Lula took office in 2003.
Even Brazilian debt denominated in U.S. dollars has outperformed most bonds sold by developed nations. Brazil's 8.875 percent 15-year bonds, Steinmetz's biggest public holding in the country, returned an average of 19 percent a year since they were issued in October 2004. That is almost four times as much as the 5.25 percent 30-year U.S. Treasury bonds he holds.
The government's benchmark zero-coupon bond has returned 36 percent since it was sold in July 2005. The gains jump to 52 percent when the real's advance is included. The Pimco Foreign Bond Fund, which is hedged against declines in local currencies, has gained an average of 4.6 percent a year in the last five years, ranking last among peers, according to Bloomberg data.
"The currency is really where the interest is," Steinmetz said. "You don't get the benefits of going international if you buy a hedged fund."
Steinmetz, who earned a master's degree in business at Columbia University in New York, also owns bonds in local currencies from Russia, Turkey, Uruguay, Argentina, Peru, Malaysia and Colombia. He has invested in African countries such as Nigeria, Ghana and Cameroon.
"My own personal approach to investing is to always push the envelope a little bit," he said.
When Russia defaulted on its debt in 1998 and emerging-market bonds tumbled, the Oppenheimer fund had its only losing year since it opened in 1995. The fund fell 5.3 percent, more than 93 percent of rivals, exposing the risks of unhedged funds. The year before, when the Asian currency crisis gripped the world economy, Steinmetz eked out a 2.5 percent gain.
"The way we see this fund is that it's more aggressive, and that's clearly been beneficial over the long term," said Andrew Gunther, an analyst at Chicago-based Morningstar Inc., which tracks the industry. "You've had to hold on tight a few times here and there. It's not for everyone."
The fund has Morningstar's highest rating of five stars, and its Sharpe ratio at the end of March was 0.63, compared with 0.03 for international funds. A higher Sharpe ratio indicates better risk-adjusted returns.
Inflation in Brazil topped 6,800 percent in 1990, half a decade after a military regime ended. Brazil is still racked by poverty, which led to the election of Lula, who has employed conservative economic policies to create greater wealth.
Investors require higher yields on the debt because of concern that the government will lose its fiscal discipline, Steinmetz said.
Today, a commodities boom, a surge in foreign investments, and a stronger currency have stabilized the economy. Brazilian growth is forecast to quicken to 4.1 percent this year from 3.7 percent in 2006, according to the median estimate of a central bank survey of about 100 economists published April 30.
"Brazil should have real interest rates that are much lower," Steinmetz said. "We think that's going to happen, but the reason why those rates are so high is because investors are backward-looking."
Fund manager: Arthur P. Steinmetz.
Assets under management: $6.4 billion.
Performance: Up 4.9 percent this year.
Significant holdings: Italian bonds, U.S. Treasury bonds, Brazilian bonds.