Brazil’s Risk Jumped, But Did Not Breach Historical High Levels

In last week’s highlights, we noted the sharp increase in Brazil’s risk – to the highest among all developed and emerging-market countries – as the market dropped precipitously amid political turmoil in that country. We thought it might be instructive to take a somewhat longer view, and distinguish between local currency (BRL) and a US dollar basis, to put the recent increase in context. In summary, we find that Brazil’s risk, while up sharply, is no higher than it has been in recent years, nor is its overall contribution to risk. In addition, changing the numeraire currency means risk levels could be quite different.

To be sure, last week’s market drop was steep, whether measured in local currency or USD. For the past 15 months, the market has been rising steadily, though, and BRL-based investors have seen strong returns for several years now. Unfortunately, the local currency’s weakness against the greenback has meant sharp losses when returns were denominated in USD.

What has this meant for risk in Brazil? After a steady decrease (along with most other markets’), the one-day jump in short-horizon risk1 associated with the extremely negative return late last week must have been a shock to many investors. But in a longer-term context, risk remains below its recent peak reached about a year ago (when risk is measured in dollars). It remains quite high relative to history in local currency, however.

Another way to look at risk in a portfolio context is comparing the country’s weight in the index (in this case we are using the FTSE Emerging index) to its contribution to overall risk. From this perspective, we can see that Brazil’s weight has declined over the past several years (with a jump in 2015), but its overall risk contribution has not fallen nearly as much2. It is far riskier than one would expect given its weight, but this has been the case for many years (again with the exception of 2015), so should not be a surprise to portfolio managers, nor does it suggest an immediate rebalancing of portfolios that include Brazil is required.

Finally, we looked at the risk of the Brazil country factor according to the short-horizon fundamental Emerging Markets model, and the real. The country factor is Brazil’s risk over and above that of emerging markets (the risk taking into account all other factors in the model). The currency risk is relative to USD. So, relative to other model factors Brazil’s risk is just about as high as it has been for quite a few years, whereas currency risk for BRL has actually been falling (as USD seems to be getting riskier relative to a number of other currencies) and did not seem to be affected by market moves last week.

1This risk forecast uses Axioma’s short-horizon fundamental Emerging Markets model, and is based on a capitalization-weighted average of all Brazilian companies in the model universe.
2Base currency is USD in this case.

Melissa R. Brown, CFA

As Managing Director of Applied Research, Melissa Brown generates unique insights into risk trends by consolidating and analyzing the vast amount of data on market and portfolio risk maintained by Axioma. Brown’s perspectives help both clients and prospects to better understand and adapt to the constantly changing risk environment.