US Fixed Income ETFs and LFTS11 Popular with Brazilians: Interest Rates or the Search for Safety?

A special type of ETF (Exchange Traded Funds) – index funds with shares listed in B3 – caught the attention of Brazilian investors. While, in general, trading of ETFs is down year-end year-to-date, fixed income has shown the opposite movement.

Looking at both ETFs and ETF BDRs (Foreign Funds Receipts Traded on the Domestic Floor), total trading volume by products that simulate fixed income indexes has grown by 250% since November.

In February, transactions with ETF stocks and BDR of fixed-income ETFs — which currently total 29 funds — amounted to R$472 million, compared to R$135 million in November and R$265 million in December, according to the data. collected on the Economatica platform.

Two simultaneous movements help to understand the results.

On the other hand, investors’ interest in investing in US fixed income has increased, given the current level of interest rates in the United States. The country’s base rate has reached a range of 4.75% to 5% annually, following this week’s monetary policy decision by the Federal Reserve (Federal Reserve, US central bank).

This highlights fixed income BDRs ETF. All five of the B3’s most traded vouchers are equivalent to US indices of government bonds and private paper, issued by companies, according to data from the exchange.

On the other hand, Brazilian interest rates – for more than six months at 13.75% per annum – leave no less.

Launched in November 2022, LFTS11 was the first post-fixture public bond ETF for B3, replicating an index formed by LFTs (or Selic Treasury). It quickly became the most heavily traded of all fixed-income index funds, with an average daily volume of nearly R$13 million in February, according to data from Economica.

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Among the fixed and variable income ETFs, LFTS11 manager Investo has 17 B3-listed funds. “In just four months, the LFT ETF has added nearly R$600 million in equity, making it our largest fund,” says Cauê Mançanares, CEO of Investo.

Receipts of international fixed-income ETFs

The average daily turnover for fixed income ETF BDRs was R$9.1 million in February, compared to R$164,000 in November, according to B3. “It’s been a year since we brought our first ones to Brazil, and at that time, there was no definite demand for international fixed income,” says Paula Salamond, BlackRock’s country manager.

He is the world’s largest fund manager and is responsible for eight of the 18 BDRs of fixed-income ETFs available in B3.

“Not that we anticipated a high interest rate cycle, but we brought in products that we knew could have a place in investors’ portfolios,” he explains. But in the face of one of the fastest and most significant rate increases the US has ever seen, financing BDRs ended up showing attractive returns, changing the history of products on national soil.

Of BlackRock’s eight fixed-income ETF BDRs, six replicate US Treasury indexes, and two invest in corporate bonds of “investment-grade” companies — that is, those with lower credit risk. Investors preferred BHYG39, a receipt from a fund that buys Treasury securities with short-term maturities (up to one year).

Another source of interest is BSHV39, the BDR of the ETF that invests in investment grade companies. The product yields about 5.3% per year in dollar terms, while BHYG39, General Securities, yields about 4.6% per year in dollar terms.

BDRs ETFs are not “hedged”, which means that their performance in Brazil also includes changes in exchange rates – which can be good or bad for earnings, depending on the economic moment.

The initial investment is low, starting at R$50, Paula recalls. All BDR ETFs have market makers and financial institutions contracted to ensure that the securities are liquid for investors.

Non-fixed government bond ETF

Maçanares, from Investo, recalls that fixed income has always been very attractive to Brazilians. With LFTS11, the potential for gains above the CDI rate (a benchmark for this asset class) was one of the drivers of the ETF – but not the only one.

According to the executive, one of the advantages of the ETF over other fixed-income investments is taxation. The income tax imposed on it varies according to the term of the investment. The highest rate is 22.5%, if recovered within six months. The lowest 15% only applies if the investment has been going on for at least two years.

In fixed income ETFs, what matters is the average maturity of the securities that make up the fund’s portfolio. In the case of LFTS11, Maçanares says, all research papers have a maturity period of more than two years — thus, the income tax rate is always 15%. Even if the investor sells his shares in the short term.

Taxes are more advantageous than those applied to direct investment in public securities, through direct treasury.

Apart from that, fixed income investments with a duration of up to 30 days are also charged IOF (tax on financial operations). In the case of fixed-income ETFs, there is no effect of this tax.

“We fell into what Brazilians are looking for today: income security in an investment they already know, government bonds,” says Masanares. “We have individual investors, who apply their contingency reserves, and corporations and fund managers, who use the ETF to allocate and preserve cash.”