Brazilian market: Discount brokers versus Full service providers and the potential growth of quantitative and neutral long short funds

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1 Brazilian market: Discount brokers versus Full service providers and the potential growth of quantitative and neutral long short funds Alexandre Póvoa Modal Asset June 8th,

2 The Brokerage Market in Brazil 2

3 The Brokerage Market in Brazil - We have seen many brokerage houses surging, living and dying in Brazil during the last 30 years; - Deep process of professionalization; - Stock Exchanges: From a Brokerage Club to a public company ; - Challenges are only changing; 3

4 BM&FBovespa Second place in the ranking by market value Stock Exchange Hong Kong BMF&Bovespa Chicago Frankfurt NYSE Intercontinental Australia Nasdaq OMX Londres Source: Bloomberg Market Value (US$ bi) 186,9 22,7 18,7 10,6 9,3 8,6 5,7 4,4 2,7 4 BM&F Bovespa Potentially, one of the highest growth level in the world.

5 BM&FBovespa Stocks, Futures, Options and Swaps Number of registered public companies in Brazil: 455 Number of traded public companies in Brazil: 376 BM&FBovespa Volume Daily traded (US$ bi) Market Cap (US$ bi) Bovespa 3,4 900 BM&F 108,4* * * Around 85% are related to DI futures and fixed income in general. 5 Source : Boletim BM&FBovespa

6 Very difficult life for brokers Very concentrated asset management industry Brazilian Asset Management Industry players R$ 1,7 trillion Six Major players - Retail banks 68% Twelve major players - Including some big investment banks 82% More than 80% of the assets under management concentrated in few players notably retail banks - An important part of the volume is directly traded with their own broker very difficult life for independent brokers. 70% of the volume is fixed income related; only 30% (equities and hedge funds) includes more aggressive flows. 6

7 Very difficult life for brokers Institutional investors and Individuals Concentration in less aggressive investments Pension Funds: US$ 300 billion (262 players), 62% concentrated in the ten biggest players. High growth segments : - State and Municipalities Retirement Funds (US$ 50 billion) and Private Retirement Funds (US$ 100 billion) - Insurance companies (US$ 75 billion) - Individuals investing in stocks Bovespa Low rotation 7 Volume not sufficient to generate high fees

8 Very difficult life for brokers Foreign investors and the ADRs as competitors BDRs/ADRs Number of companies Daily traded volume (US$ million) ADRs- Brazilian companies Fonte: American Depositary Receipts (ADRs) 27 companies available traded at high level of liquidity in New York. Transaction costs (IOF is the most recent one) incentive the use of ADRs, NDFs and all types of Brazilian derivatives traded abroad. 8

9 BDRs/ADRs Very difficult life for brokers - BDRs: Brazilian investors and the home bias BDRs- Foreign Companies Number of companies 28 Daily traded volume (US$ million) 45 * Fonte: Agrenco and LAEP (almost two option type companies) correspond to more than 80% of the volume. Home Bias: Brazilian Depositary Receipts (BDRs) 28 foreign companies available and traded at poor liquidity conditions at BM&Fbovespa platform. 1 - Stronger than the average in Brazil because of the very high interest rates (for fixed income and FX transactions) and the eternal expectation of a lower opportunity cost (for stocks). 2 It is almost unexplainable why Brazilian institutional investors do not demonstrate any interest in investing, as a powerful diversification tool, in sectors 9 not traded in Bovespa Ex: Pharmaceuticals, High Tech, multinationals

10 All conditions together = More than 80% of the assets under management are concentrated in few players notably retail banks that have their own brokerage houses. (+) 70% of the volume is fixed income related with low level of investment aggressiveness; lower margins (+) Pension funds Big industry, but still very conservative Very low rotation, no high fees. (+) High growth segments (individuals and state and municipalities retirement funds) still small, no high fees (home broker competition) (+) Very tough competition from the ADR market, not compensated by the BDR segment (strong home bias) IOF level has worsened the situation 10 = Very difficult life for brokers in Brazil.

11 Very competitive brokerage market Very high number of active brokers at BM&FBovespa (in all markets): 98 The lag between the research broker and discount broker has widened dramatically The Distribution capacity (global) has assumed enormous importance. There is no room for a middle of the way broker It s very expensive to be a research broker nowadays; to be a discount broker, you only survive counting on high volume traded and a rigorous cost control. 11

12 Final Consequence: Very tough and competitive market -Old Bovespa Fee Table: Research and Discount brokers; Respectively, average fees of only 9 basis points (82% rebate) and 4 basis points (92% rebate). -BM&F broker (2 basis points) and home brokers almost for free. Brokers Average rebate Bovespa - Research Broker 80% - 85% Bovespa - Discount Broker 90% - 95% BM&F 95% - 98% Home Broker 95% - 100% (!!) Source: Modal Asset 12 Question: Is a low cost status compatible with a high quality in services? How do brokers compensate their potential losses?

13 The growth potential of quantitative and neutral long short funds in Brazil 13

14 Quant funds Very low participation in the market daily flow Quant Funds Brasil EUA Other markets Assets under management US$ 1 billion US$ 467 billion US$ 370 billion Participation in the fund industry Around0,1% ofthetotalaum Brasil Around4 % ofthetotalaum EUA Around3,5% ofthetotalaum world ex-eua Source: Economática, Valor Investe June/2001 Part. Quant. Funds in daily high frequencytrades Stock Market Futures Market EUA Europa Brasil* 54% 38% 35% 40% 6% 4% * In the Brazilian case, it is the participation in the traded volume. 14 Source: Rosenblatt Securities, BM&F Bovespa e Valor Investe, June 2011

15 Quantitative and long short investments gain attractiveness in non-trend and low vol markets Quantitative and Long short funds A lot of room to grow in number of funds and volume. Quantitative Funds: Only 0,1% of the total Brazilian asset management industry (only 37 funds); Long Short Funds: Around 6% of the Brazilian asset management industry the neutral long short represents only one third (2% of assets under management); - In trend and high volatility times : Diversification (no strong correlation with any segment in particular) 15 - In non-trend and low volatility times : Return + Diversification!

16 Quantitative and long short investments gain attractiveness in non-trend and low vol markets IBOV x VIX Dólar x VIX % 35% 30% 25% 20% 17% 15% 1,90 1,85 1,80 1,75 1,70 1,65 1,60 1,55 1,50 27% 30% 25% 20% 15% 10% 10% 5% jan-10 fev-10 mar-10 abr-10 mai-10 jun-10 jul-10 ago-10 set-10 out-10 nov-10 dez-10 jan-11 fev-11 mar-11 abr-11 mai-11 10% jan-10 fev-10 mar-10 abr-10 mai-10 jun-10 jul-10 ago-10 Dólar set-10 out-10 nov-10 dez-10 jan-11 fev-11 Dólar 30D VIX mar-11 abr-11 mai-11 IBOV IBOV 30D VIX Ibovespa has lost volatility and trend, floating within the and levels since September / The Brazilian currency has lost volatility and trend, floating within the R$ 1,60 and R$ 1,70/US$ band since October / 2009.

17 All conditions together = Volatility keeping current low levels in many segments in the short term; no-trend in the markets in general. (+) Interest rates going down in the medium term, automatically lowering risk aversion in general more money to be invested in hedge funds and equities. (+) Interest rates going down in the medium term, automatically making big investors (institutional segment and individuals) to look for diversification. Development of new high technology platforms = Gradual growth in number and volume for the quant and long short funds in the Brazilian market. 17 (+)

18 Let s keep in touch Alexandre Póvoa (21) apovoa@modal.com.br Atenção: esta apresentação não pode ser retransmitida sem autorização formal. Qualquer reprodução, disseminação, alteração, distribuição e/ou publicação desta apresentação é estritamente proibida. Notice of Confidentiality: this document should only be read by those persons to whom. It is addressed and is not intended to be relied upon by any person without subsequent written confirmation of its contents. Any form of reproduction, dissemination, copying, disclosuree, modification, distribution and/or publication of this document is strictly prohibited. Modal Asset Management Ltda. Praia de Botafogo, 501/ Rio de Janeiro. RJ. Brasil. Tel: Fax: Ouvidoria: