Brazil's central bank to reduce banks' bets in foreign exchange market

andres del risco

Emerging-market bond company OppenheimerFunds's have sold all Mexican and Brazilian sovereign debt holdings hoping to exposure paring to currencies of countries intervening in foreign-exchange markets.

OppenheimerFunds who is among the biggest emerging-market portfolio managers in the U.S and oversees about $11 billion in emerging-market debt have reduced their exposure to Chile's peso and Brazil's real as central bankers in these countries take steps to prevent their currencies from appreciating.

OppenheimerFunds cut their exposure to Brazil and Mexico sovereign bonds at the end of last year because they see little room for substantial returns on these assets, whose spreads with Treasurys are already narrow. In search of higher returns in emerging markets, thier emerging-market teams are moving more money to higher yielding emerging-market corporate debt. For exposure to Brazil and Mexico, her funds now own only corporate debt from those countries.

Zervos's funds can also invest in local currency bonds to get exposure to a country's currency and benefit from any potential appreciation. Her funds are increasing their exposure to the South African rand, partly because it stands to benefit from increased demand for commodities.

Zervos's comments highlight the changing landscape that emerging-market fund managers are facing as money rushes into these fast-growing regions. As more money has moved to the developing world, spreads between emerging-market sovereign bonds and Treasurys have tightened significantly, making it harder to project big returns on such investments. Meanwhile, the surge in capital flows to developing countries has driven up their currencies, pushing local policymakers in countries from Brazil to Chile to intervene in foreign-exchange markets. That is making emerging-market investing more challenging.

"Last year was a pure rebound year, extending from 2009. We got through the double-dip fear and then it was all ships ahead," she said. "But this year we are worried about intervention, we are worried about central banks being behind the curve and it makes the outlook much trickier."

Earlier in January, Chile's central bank announced that it would intervene in the local currency market with plans to increase its foreign currency reserves by $12 billion in 2011 in an effort to hold down the peso and assuage the worries of Chile's exporters.

Zervos, who is based in New York, said her funds had a small exposure to Chile's peso, which she completely erased right after the intervention was announced, even though she has a strong fundamental outlook for the Chilean peso. Along similar lines she has cut back exposure her funds have to the Brazilian real via local currency bonds, bringing down that allocation to marketweight from overweight.

"There might be every macro reason in the world to love the Brazilian currency, but the randomness of policy to try and stop appreciation makes us want to have a smaller position," Zervos said.

Zervos, an emerging-markets veteran, is portfolio manager of the Oppenheimer International Bond Fund, Oppenheimer Emerging Markets Debt Fund, and Oppenheimer Global Strategic Income Fund. Her comments underscore how countries risk pushing even longer term investors away when they intervene in foreign-exchange markets.

"I tend to be more overweight stories with good fundamentals plus lack of intervention," she said. She is bullish on the Mexican peso on expectations that the U.S. economy will keep recovering and pull Mexico with it. Also, Mexican authorities don't interfere with the currency.

Zervos says despite her more cautious tone on Brazilian sovereign bonds, she is bullish on corporate debt from the country. "That's where the best bang for the buck is," she said, referring to high yield emerging-market corporate bonds.

Brazil's central bank recently moved to reduce the size of banks' bets in the foreign-exchange market to protect the financial system and investors have grown more concerned that the government will be more aggressive in halting the currency's gain.

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