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Rubles, Reals, and Institutional Quality

August 17, 2021 | Multi-Asset


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Our team recently increased existing long exposure to the Brazilian real (BRL) and Russian ruble (RUB)—a decision justified by the Where and Why stages of our investment process.

As a reminder, we seek to assess risks and opportunities in the global markets based on three stages: Where, Why, and How. In the Where stage, we seek to identify where prices differ from fundamental value. In the Why stage, we seek to understand why prices differ from fundamental value. And in the How stage, we seek to appropriately capture these value/price discrepancies within a diversified portfolio.

Both the BRL and RUB have strengthened, but we believe they remain significantly undervalued against the rest of our universe. We believe this is the fundamental justification coming from the Where stage of our process.

We believe justification also comes from the Why stage of our process, specifically relating to ESG-oriented influences (in this case, primarily social and governance factors). We strive to evaluate country-level exposures using, in part, a number of these kinds of factors to create a proprietary “policy” score. One influence for which this score accounts is central bank policy, where appropriate policy and, especially, independence are key, in our opinion. Both Brazil and Russia have increased interest rates this year in response to higher inflation, despite their government pursuing growth agendas coming out of the pandemic-driven recession.

We don't just look at the absolute level of value but also account for the trend of improvement.

It's worth noting that in cases like this, we don't just look at the absolute level of value (i.e., “invest in the good” and “avoid the bad”) but also try to account for the trend of improvement (or lack thereof)—how situations are evolving. What we've discovered over the years is that improvements in these types of factors or influences typically create a “tailwind” environment for a country's assets and currency.

We don't often emphasize it because it's an inherent part of what we believe is a robust valuation framework. But I mention it now because Brazil is, in our opinion, an improving environment—especially from the perspective of governance in our opinion  (Lava Jato—driven corruption reform and appropriate fiscal policy evolution spearheaded by its current finance minister). To be sure, it is improving from a lower starting point than, say, the United States, but it appears to be improving, and that aspect helps support the case for an increased long exposure on a fundamental basis.

We believe Russia, on the other hand, is not really improving at this point. On a relative basis we think it is slightly worsening. But even with that incorporated within our valuation analysis, we believe RUB remains a fundamentally attractive currency, thanks, in part, to hawkish commentary and behavior from the central bank.

We are not expecting to see a rise in interest rates of any substance for the next year or so, and that is a part of the reason we remain bearish on the U.S. dollar.

In contrast to some of the observations on BRL and RUB, one place from which we are not hearing (enough) hawkish commentary is the United States, which just can't seem to find enough money to spend for society. This approach disrupts the normal operation of markets.

We did see an increase of the interest rate on excess reserves about a month ago, but that was a very small increase—more of a signaling in our opinion. We are not expecting to see a rise in interest rates of any substance for the next year or so, and that is a part of the reason we remain bearish on the U.S. dollar (USD) (in addition to overvaluation on a relative purchasing power basis) and were happy to sell more USD (increasing an existing short exposure) against the two previously referenced currency purchases.

Given these Where and Why analyses, we believe that a significant opportunity has opened for both BRL and RUB relative to the USD.

Brian Singer, CFA, partner, is a portfolio manager on and head of William Blair's Dynamic Allocation Strategies team.

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