Brazil fund managers stay selective on cheap cyclical stocks

With an eye on next year’s elections and a scenario in which Brazil’s Central Bank has little room left to continue easing monetary policy, portfolio managers have become more selective when investing in cyclical stocks. The preference has been for companies that are better positioned to remain resilient even as economic activity slows.

• Credit funds also hit by market risk
• Brazilian investors retreat to safety, flocking to floating-rate bonds

Another strategy has been to increase allocations to paired trades—taking a long position in one domestic cyclical stock while shorting another—to hedge portfolios while simultaneously taking advantage of investment opportunities.

“We’re not rotating into domestic cyclicals as a sector. This is an environment where you have to be extremely selective when choosing domestic assets,” said Rodrigo Mello, head of equities at Tenax Capital.

Mello said he has favored companies that can weather a slowdown with greater operational resilience while also benefiting from a potential decline in long-term interest rates. “In other words, businesses with more predictable cash flow, lower sensitivity to household income, and attractive valuations,” he said.

Among Tenax’s preferred names is Smart Fit, a position the firm has recently increased. Mello said the company’s membership fees remain relatively low compared with other gym chains, while consumer demand for fitness services continues to strengthen. “A gym membership at this price is unlikely to be the first expense households cut,” he said. “Smart Fit should be better insulated in a slowdown scenario, and its valuation is attractive.”

Mello also sees opportunities in shopping mall operator Allos, which he believes is trading at a discount. The company’s diversified revenue streams, including rental income, provide greater resilience in an environment of persistently high interest rates and slowing economic growth. He noted that the latest economic activity and labor market data point to weaker momentum, but not enough to suggest a slowdown significant enough for the Central Bank to have substantial room for additional cuts to the Selic policy interest rate.

Given expectations that future rate cuts will be limited, Mello said he has focused on long-short trades in discretionary retail stocks, which could be more vulnerable than other sectors if economic activity weakens further.

Vinland Capital has also expanded its use of paired trades. Rodrigo Andrade, the firm’s equity portfolio manager and partner, said election-related uncertainty, combined with heightened geopolitical risks and the prospect of higher U.S. interest rates, has increased the need to hedge portfolios without giving up exposure to potential gains.

“We can’t afford to miss the party if there is one. The only thing I know about elections is that they’re unpredictable. We’ve had a plane crash, a stabbing,” Andrade said. “Long-short strategies protect you against these exogenous events that are beyond your control. Friday’s lower-than-expected IPCA inflation reading gave the market a boost, so we ended up with a larger net long than short position in cyclical stocks.”

The move does not mean Vinland has become broadly more optimistic about domestic cyclicals, but rather that it is making more selective bets. “We’re separating the wheat from the chaff. You can’t just see a cheap valuation and start buying. Stocks are trading at these levels for macroeconomic reasons,” Andrade said.

Among the firm’s preferred investments are homebuilders focused on the My Home My Life housing program, which Andrade believes will continue to perform regardless of who takes office in 2027. “Low-income housing programs are a key pillar for governments, regardless of who wins,” he noted.

Vinland’s preferred names include Direcional and Moura Dubeux, alongside Cyrela, which the firm views as an indirect way to gain exposure to Plano & Plano while investing in a stock trading at a significant discount. Andrade also said the firm has a more positive view of highway concession operators such as Motiva and EcoRodovias, as well as utilities including Copasa and Sabesp.

Despite expectations of slower economic growth, Mantaro Capital believes current valuations have become so depressed in some cases that they already reflect a no-growth scenario. “At current prices, you’re buying these stocks assuming no growth whatsoever. Today’s valuations already provide downside protection for your portfolio. We’re getting the upside potential from future growth almost for free,” said Paulo Abreu, a partner and portfolio manager at the firm.

He pointed to jewelry retailer Vivara as an example. According to Mantaro’s estimates, the stock is trading at about eight times expected earnings over the next 12 months, close to its historical lows. For comparison, around the time of its initial public offering in November 2019, the forward price-to-earnings multiple stood at roughly 22 times.

“Vivara generates excellent returns,” Abreu said. “There were governance issues, but those have already been addressed. The company’s products also tend to be less affected by weaker disposable income because of its target customer base.”

Another example is car rental company Localiza, which Mantaro estimates is trading at about nine times expected earnings over the next 12 months, also close to historical lows. “It’s our largest position today. It’s an asset that is highly sensitive to interest rates, but we see the current valuation as very attractive even if economic activity slows,” Abreu said. Mantaro currently has above-average exposure to domestic cyclical stocks, focusing on companies with differentiated competitive positions and deeply discounted valuations.