Brazil's Luis Stuhlberger captains HG Green with contrarian views

Like Brazil, which is enjoying its long-awaited moment in the sun as host of the 2016 Olympics and with a red-hot stock market, Stuhlberger is on a winning streak. As head of asset management at Credit Suisse Hedging-Griffo, a leading Brazilian brokerage house that is also majority owned by the eponymous Swiss giant, Stuhlberger runs one of the oldest and largest hedge funds in Brazil, the HG Verde Fund. And in 2001, he started the offshore version, called HG Green Fund, a translation of the Portuguese. Stuhlberger's newer HG Green occupies a unique place in Brazil's investment industry. The fund is the best long-term performer in the market for Brazil funds and one of the earliest of its type. HG Green, which invests in debt and equity, has an annualized return of 19.77% since 2001 and was up 79.44% for 2009, net of fees. That's without leverage and in large part due to a smart bet on the Brazilian real appreciating against world currencies. (In contrast, the AR Latin American Debt Composite was up 17.53% through November, and the AR Latin American Equity Composite—the top-performing hedge fund strategy—rose 29.99%).

HG and its HG Green Fund are getting noticed abroad as Brazil becomes a more popular investment destination. That's despite last October's 2% government tax on foreign stock and bond purchases, slapped on to stem capital inflows and stop the rise of the real after it gained 35% against the U.S. dollar. As for 2010, the Brazilian central bank's survey forsees GDP rising by 5.2%.

Stuhlberger does not fully share the wave of domestic and foreign euphoria for his country's macro prospects. "Did you hear the one where the Brazilian asks God, 'God, when will Brazil be a great country?' And God answers, 'Not in my generation,'?" jokes Stuhlberger.

Among other strategies, he is looking to become a major player in Brazilian real estate investment trusts. Taxes are onerous and prices are high, with a Big Mac selling for more in São Paulo than in London, he says. "The really big emerging market story is not the BRICs [Brazil, Russia, India and China] but China, Taiwan, South Korea, Singapore and Hong Kong. These countries have made huge changes in world history."

The recession that rippled out from the rich world initially blindsided Brazil, but its impact on the Latin giant was short-lived: the country suffered a short two-quarter recession before the economy started to recover in the second quarter of 2009, recording estimated growth of close to 0.2% in 2009 as a whole. Moreover, financial markets were helped by investors' search for yield in a world where real interest rates hovered near zero, given the extensive use of the dollar-real carry trade.

Equity market performance was heavily influenced by the performance of the currency. The real gained heavily in 2007, lost nearly 50% in 2008 and was up some 33% last year. In U.S. dollar terms, the main Ibovespa index was up 73.39% in 2007, dropped 55.45% in 2008 and was up 145% in 2009.

That's why Brazilian hedge funds are once again attracting capital. Brazil had R$320 billion ($183 billion) in onshore hedge fund assets under management in November 2009, and the onshore market had witnessed more than R$31 billion ($17.8 billion) in new investments in the first 11 months of 2009, according to the National Association of Investment Banks in São Paulo. That's a big turnaround from the last quarter of 2008 and the first quarter of 2009, when the hedge fund business saw severe withdrawals with the offshore HG Green suffering particularly from fund-of-funds withdrawals.

The whole HG Green family manages $6.75 billion, with $5.15 billion in HG Verde and $1.6 billion in HG Green, as of December 2009. The strategy of the onshore and offshore funds are the same, but the returns are quite different because of the FX exposure on HG Green, with HG Green up 79.44%, net of fees, last year. HG Verde netted 50.37%.

The pillars of HG Green are deceptively simple. It is an unleveraged, macro, multiasset Brazil fund that is two-thirds fixed income and one-third equities, and which can be fully exposed to the real or fully hedged. This is the DNA of the fund, and it has not changed over the 10-year life of the fund, says Stuhlberger. HG Green seems to differ little in its makeup from competitors. Most hardly stray from the beaten path of government bonds, dabbling in U.S. dollar-real rates and adding a smattering of equities to jazz up the results.

This strategy is so standard that a disparaging term, "Brazil kit," has been coined for it. Even if multiasset funds want to be distinctive, uneven liquidity in mid- and small-cap equities, suspect pricing in corporate bonds and a limited range of derivative instruments hinder flexibility.

With HG Green's stellar performance, no wonder it has been closed to new investors since November 2006, with a brief soft opening to existing clients last year. The one blight is 2008, when HG Green lost 17.49% although it outperformed most long equity and local currency funds, which lost 60% to 70%, points out Stuhlberger.

Another major difference with rivals is that the fund is unusually active in its management of foreign exchange and its commitment to equities. "Most mandates in Brazil are either fixed income or equity. Of course, multiasset funds exist, but when you look, the vast majority have negligible equity portions," says Stuhlberger.

There are also fundamental differences between HG Green and its local competitors in the depth and breadth of research from the fixed-income, currencies and equities teams. They draw trends and parallels from around the world and express them through Brazilian instruments.

The HG Green teams constantly look to translate ideas across sectors, seeing how a micro equity idea might affect the bigger picture or the other way round. At meetings, the team hopscotches between equity and fixed income and may play out the same idea by being long equity and short inflation. "This is arguably one of the few teams that do proper homework outside Brazil," says Enio Shinohara, who is an ex-partner at fund-of-fund manager Claritas Investimentos and an ex-alumnus of Stuhlberger. "?'Think global, act local' has become a mantra, but the reality is that it is not that common in Brazil."

Stuhlberger is a magpie, taking ideas from eclectic sources. He not only spends time with Wall Street analysts but makes sure he regularly meets industry leaders and entrepreneurs. He blends and alchemizes ideas from politicians, business people and everyday events such as traffic trends into his investment portfolio.

One advantage of all the foreign interest in Brazilian markets is that he gets to speak to overseas hedge fund managers, who often give him useful perspectives. Foreigners show more sangfroid than Brazilians about domestic politics and have taught him that the country tends to pull through crises without too much bleeding.

"During the Mensalão [a widespread illegal contributions scandal in the run-up to Brazil's presidential election in 2006], we thought this would have much more impact on the market, but the foreigners said, 'No, it's a buying opportunity.' They were right," says Stuhlberger. "Generally we trade better in the bear market than the gringos. They see the trends and sometimes trade better in the bull market but tend to cut and run in times of crisis," he says.

Finally, Stuhlberger is prepared to own up to mistakes and learn from them. He peppers the conversation with phrases such as "Sometimes it works, and sometimes it doesn't" and "We are always considering if we are wrong or not."

Stuhlberger is very much a product of Brazil. After attending the highly competitive Colégio Bandeirantes and the Escola Politécnica of the University of São Paulo, where he graduated in engineering, he quickly showed a knack for markets, starting in the commodities field, trading gold, coffee and beef.

It was not until the 1990s, when hyperinflation had been tamed, that multimarket funds were able to spring to life in Brazil. Stuhlberger soon recognized their potential. He formed a partnership and later became a fund manager, opening onshore HG Verde in 1996. The offshore version, HG Green, was launched four years later.

Stuhlberger speaks passionately and with a refreshing candor, dismissing the naïveté of foreign yield-chasing fixed-income investors who jump feetfirst into Brazil, or taking a sideswipe at the greed of the investment banking industry. He acknowledges that some of the fund's most spectacular successes have come when he has bet heavily against prevailing wisdom. His mind-set echoes a famous expression coined by Brazilian playwright Nelson Rodrigues" "All unanimity is stupid."

When Stuhlberger started HG Verde, a recovering Brazil was still very much the investment Wild West, a frontier market where prices went haywire on a single event and firms went belly-up overnight. "I have been in the markets for 30 years, and I have seen really wild times. At times, we had to be like street dogs to survive," says Stuhlberger.

In 1997, just one year into his run as fund manager, came the first of Stuhlberger's big coups. When the Central Bank of Brazil jacked up rates to 19%, most Brazilian managers ran to invest in fixed-rate paper, seeing this as the cycle's peak. Stuhlberger, concerned about the rapidly deteriorating situation in Asia, bought 30-day futures instead. When the Asian markets tumbled, Brazil faced massive capital flight and rates went up to 43%, and HG Green cashed in.

In the last 10 years alone, Brazil has experienced five crises, which have all provoked massive volatility and made these markets an invaluable training ground for investment managers. Those who were in the markets during Brazil's 1999 devaluation understand speculative attacks, which helped them interpret the currency run in Iceland in 2008, Stuhlberger says. Such managers naturally took 2008's global crisis in their stride.

In Brazil's more serene macroeconomic waters of today, equity markets have provided the most volatility and have heavily influenced recent performance. An equity team of eight advises on HG Green's portfolio.

In a fund that absorbs many global ideas, global and sector comparisons are standard, and macro and micro ideas are batted back and forth. When HG Green looks at Brazilian mining company Vale, it considers not just fundamentals but the wide Asian demand picture and the value of Vale relative to Australian peers, for example, says CSHG's Artur Wichmann, a global fund manager who has worked in Zurich and Toronto for UBS Global Asset Management and has lived abroad.

When one analyst suggests an oil buy, a colleague might ask about demand destruction, pointing out that China is investing heavily in solar companies. What matters is that analysts can win others over with a lot of data. Debate comes naturally: "We are Brazilians; we argue about everything," Wichmann jokes.

Stuhlberger sees equity as the toughest market in Brazil today. Pricing is ferociously competitive. And the market is prone to bubbles and gloom. Investors got carried away in the IPO wave that swept Brazil in 2007. "People were buying everything without reading and understanding. Some companies had corporate governance issues. Others were ridiculously overvalued, and in some cases, valuations were based on mere promises," says Stuhlberger.

Brazil's equity market caused many of the headaches the fund experienced in 2008. It was roiled by the global crisis, and HG Green was not prepared for the depth of the hit. "In September 2008, we had a 35% position in equities. That was a mistake. If I had predicted the crisis correctly or even part of what happened, I would have been at 20%," says Stuhlberger.

Worse still, HG Green had invested heavily in Brazilian real estate stocks, particularly low liquidity mid-caps. "We started buying the stocks earlier than we should. They looked very cheap, and after Lehman they were clobbered," says Pedro Sales, a CSHG equity manager. It was a valuable lesson in the perils of liquidity. Many small caps fell by 50%, whereas larger caps typically suffered a 20% drop.

The fund did not, however, cut and run but increased positions in size. Real estate mid-caps were trading at below half book value and still had the same strong management with 20 years of experience. When the market recuperated, the stocks went up 200% to 300%, says Sales.

If Brazil's equity market is to be handled with caution, the fixed-income and foreign exchange markets sometimes offer low-hanging fruit.

The foreign exchange market has been a key driver of HG Green's profits. While most Brazilian funds consider the real-U.S. dollar rate as the lynchpin, Stuhlberger considers the real's relation to a wide array of currencies. The real and Australian dollar are correlated, and there are even parallels between the real and the currencies of Mexico and Eastern Europe, which have a similar industrial base, says Wichmann.

Like equities, foreign exchange markets have had moments of great volatility, and overreactions mean that Brazil can throw up sudden opportunities. With the dollar-real rate approaching 1.65 in summer 2008, the fund had been unhedged for the better part of two years, benefiting from massive real appreciation. "At that point we felt the global antidollar sentiment was overextended, and we looked at the option markets and saw players selling volatility at historically low levels. We could buy a 12-month for around 12%, and nowadays it's closer to 19%, so we bought USD-BRL call spreads for 100% of the portfolio," says Luiz Parreiras, CSHG strategist.

HG Green sustained some mark-to-market losses in the short term but found itself protected against the fallout from Lehman Brothers. "But if you'd asked me, 'Would you have imagined that the year would end with the real at 2.30?' I would have answered no. If I'd known I would just have bought options when it was at 1.7," Stuhlberger adds.

The real's drop against the greenback also exposed aggressive bets against the U.S. dollar through the forward markets by some of Brazil's best-known companies, including meat packer Sadia and paper and pulp firm Aracruz. Huge losses played havoc with the corporate bond market. Even the most solid names floundered as investors jettisoned any company with dollar debt.

When markets sold off, São Paulo energy utility Companhia Energética de São Paulo bonds tanked. True, the company has a heavily leveraged balance sheet in line with peers, but the company is state owned and has only long-term dollar debt. HG Green was able to buy real-denominated inflation-linked bonds at inflation plus 20%.

As ever, Stuhlberger calibrates global and domestic trends to understand the Brazilian economy. He believes that Brazil faces major fiscal problems. It has not pushed ahead with urgently needed tax and labor reforms, and the government has boosted payrolls substantially through salary increases and hiring. The new 2% tax on foreign stock and bond purchases spurred by the rise of the real against the dollar had little effect on the currency, but did have a short-term effect on equity markets, which fully recuperated by mid-November. That has given rise to concerns that the government may intervene again. Stuhlberger believes the government had to act to avoid the Brazilian currency's appreciation.

Stuhlberger is also concerned by the state policies of lending heavily to development and public banks, which is leading to a sustained rise in gross debt. Gross debt may end next year at 80% of GDP and could drive up costs of long-term financing over time.

High fiscal spending makes a long-term inflation hedge interesting. "We might lose money on a long-term inflation hedge or the slope of a yield curve. But if we lose money, we lose it drop by drop, slowly, every day. Then there may be a market event, and the hedging makes a very huge market jump in your favor," he notes.

If Stuhlberger is right and government spending comes back to haunt the debt markets, this would not be the first time the bond market has been overvalued.

Government debt was also seriously overbought in May 2007. In the first quarter of that year, base rates were around 12.5% and inflation was low, explains strategist Parreiras. Markets got caught up in pricing long-term convergence, pushing 10-year rates below an unprecedented 10%. The trade was very crowded, and with economic growth at above 6%, the managers saw low inflation as temporary. "The market was behaving like it was having a picnic at the edge of a volcano. So we said, 'OK, let's go for it,'?" adds Stuhlberger.

HG Green managers started to buy 10-year paper, taking the position to 70% of the portfolio, and were vindicated when rates ended the year at 13.20% before heading to 15% in mid-2008, Parreiras says.

The threat of inflation is a bigger and more immediate concern for Stuhlberger than falling interest rates, the bête noire of most Brazilian asset managers. As government debt is the staple for hedge funds, the majority view is that the secular fall in rates will force them into riskier strategies to maintain returns, including equity and other new asset classes and leverage. The interbank rate was at 8.75% in early January after sliding five full percentage points since the start of 2009. It has certainly been a key factor in attracting more money from fixed-income funds, which are yielding much less in Brazil, making funds with an equity component more attractive. Another scenario is rising rates, which futures markets are pointing to.

Stuhlberger bats off the long-term worries over falling rates. Yet he acknowledges that if rates fall further, funds will need to rev up returns through equity and leverage, and admits that will be challenging. "In 30 years, I have never used leverage. I am an asset allocation person. I don't even know how to build leverage." But the macro challenges of inflation and high prices are much bigger than these worries, he thinks.

SHG faces an additional uncertainty. In 2011, its contract with Credit Suisse, which owns a 50% stake and one share, expires. Stuhlberger says the key for him is that the Hedging-Griffo operation should stay a stand-alone entity with its own processes, procedures and remuneration policies. The Credit Suisse name has been very important for private banking, he acknowledges, but its impact is more neutral in asset management.

The other challenge is to grow the breadth of funds in line with Brazil's expanding markets while maintaining the firm's reputation for performance.

Stuhlberger sees enormous upside in Brazil's real estate market and aims to ramp up its role in the REIT market. The global skills of the CSHG team can be used to help Brazilians invest abroad as restrictions are lifted too. Today, Brazilians can invest 20% of their assets outside the country.

Stuhlberger also thinks the firm can offer global equity funds for foreigners that outperform exchange-traded funds. "Now we are in the era of ETFs, which distort market prices because of their weight. We have a great opportunity." HG's Brazilian long-only large-cap equity fund substantially outpaced ETFs last year.

HG Green is the great survivor, the Rocky Balboa of hedge funds, a feat not to be disdained in turbulent Brazil. It has thrived by sticking to its knitting, and the philosophy remains simple, says Stuhlberger. "We buy an asset class that offers the most risk-adjusted return and short an asset class that offers less return-adjusted risk."

Underperformance is punished mercilessly and swiftly by Brazilian investors, who exploit Brazilian legislation with its ban on lock-ins and insistence on publication of daily NAVs to switch funds alarmingly often. Foreign funds of funds withdrew from Brazilian hedge funds during the financial crisis, due to the Brazilian funds' liquidity. But Parreiras believes that Brazil's more transparent, mutual fund-style regulation is a long-term advantage.

That may be so, but it makes the life of a Brazilian fund manager, already sailing in turbulent waters, even harder to predict.