Bermuda: Update On The Brazilian Hedge Funds Industry

Last Updated: 10 February 2008
Article by Bryan Hunter

The Main Offshore Funds Jurisdictions

The pre-eminent offshore jurisdictions for the establishment of investment funds are the Cayman Islands, the British Virgin Islands and Bermuda. Cayman alone boasts over 8,300 regulated funds, the BVI is estimated to have approximately 2,400 regulated funds and Bermuda is estimated to have approximately 2,200 regulated funds. There is also a significant number of unregulated and closed ended funds in each of these jurisdictions which are not generally included in the statistics.

There are many similarities between these jurisdictions, but each also has certain distinguishing features. The similarities between these jurisdictions include that each jurisdiction has a trustworthy and reliable legal regulatory system, each has a stable and business friendly government, each is tax-neutral for international fund vehicles and without exchange controls in relation to international fund vehicles and each has a well developed regulatory system that is compliant with international standards. Also, the regulatory approach in each jurisdiction in relation to hedge funds is based primarily on the principle of full disclosure of material terms to sophisticated investors rather than on a prescriptive approach. This gives operators significant flexibility when structuring their funds.

All of the jurisdictions offer flexibility in the structure of investment funds, which may be established as companies, partnerships or unit trusts depending on the client's requirements, which are often driven by onshore considerations. It is possible to establish funds as segregated portfolio or segregated cell companies, which offer cross-class liability protection and provide an alternative to the traditional umbrella fund structure.

The reasons why the Cayman Islands have established themselves as the leading offshore domicile for hedge funds include the availability of high-quality professional service providers, the absence of a regime that stipulates the jurisdictions in which a fund's service providers (other than its auditors) should be located and the existence of a regime that allows funds to be established in the Islands quickly and cost-effectively. Of course, many of these features have been emulated by the primary competitors of the Cayman Islands, but the Cayman Islands' success continues to grow on itself as both investment managers and investors have grown accustomed to, and comfortable with, the establishment of the funds in the Cayman Islands.

Each jurisdiction has its own categories of investment funds with certain distinguishing features and each has certain advantages and disadvantages. For example, the BVI are regarded as being the most cost-effective of the leading offshore jurisdiction in which to establish an offshore fund and Bermuda is regarded as the jurisdiction of choice for offshore funds that have an insurance focus, given Bermuda's leading position in the offshore insurance industry.

For the Brazilian investment manager who intends to target non-Brazilian investors there remains valid reasons for the establishment of a hedge fund in an offshore jurisdiction. Fortunately, for such an investment manager there are several high-quality offshore jurisdictions from which to choose.

Recent Developments Of The Brazilian Investment Funds Industry

The Brazilian investment funds industry has experienced strong growth during the first part of this decade, not only in terms of assets under management, but with respect to the diversification of the types of funds that have been introduced in the market.

Total assets under management have grown 94.83% from December 2000 to June 2007, achieving R$ 1.039 trillion1 (US$ 539 billion 2).

Also, it should be noted that the Brazilian investment funds industry currently ranks as the 11th largest in terms of assets under management3.

During the same 7 years period, the growth of hedge funds has exceeded by far the growth in the rest of the funds industry, showing an amazing 1,003% growth in Brazilian Reais (1,020% in US$), reaching an amount of US$127 billion under management. The fixed income funds have grown 22.26% and the equities funds have grown 177% during the same period.

There are several reasons why the hedge funds industry in Brazil has grown more rapidly than the rest of the funds industry. In our view, the two main reasons are: (i) the decrease of interest rates in Brazil during the period; and (ii) the creation of numerous independent asset managers (i.e. asset managers not affiliated with any Brazilian or foreign banks).

The Selic interest rate in Brazil4 has decreased from more than 40% p.a. in 1999 to less than 12% p.a. in July 2007. The interest rates currently available in Brazil are still some of the highest in the world, but such a significant drop in the available interest rates has had several effects in the Brazilian economic environment.

One obvious impact has been the reduction of the returns in fixed income funds, especially because such funds invested the vast majority of their portfolios in Brazilian sovereign bonds (which is understandable given the high interest rates paid by such bonds, as referred to above).

The investors in Brazil started to realize that they would need to take more risk on their investments in order to maintain the same level of returns and the obvious solution to this need was to invest in hedge funds.

The Brazilian funds industry has since its early stages been "dominated" by banks in Brazil, mostly by retail banks with large distribution channels. In the late 90s and early 2000s the consolidation of banks in Brazil made the funds industry even more concentrated.

As has happened in other parts of the world, a significant number of senior executives who were employed by banks that merged with or acquired other banks, including those involved with their employer's asset management or investment businesses, were unsatisfied with the new environments in the resultant organizations and decided to leave the banks voluntarily, or –were made redundant, as often happens in such situations.

These three factors taken together resulted in the establishment of a significant number of new independent asset managers, which were formed with the main purpose of managing hedge funds.

This in turn resulted in the more rapid development of the hedge funds industry in Brazil in comparison to the rest of the funds industry in Brazil.

Obstacles To A Greater Development – Attractiveness Of Offshore Jurisdictions

Notwithstanding the enormous increase in the assets managed by Brazilian domiciled hedge funds in the last several years, the Brazilian hedge funds industry faces several obstacles to greater development, especially when compared to some offshore jurisdictions. The main ones, in our view, can be summarized as follows:

1) The high level of bureaucracy to be dealt with by foreign investors who invest in Brazilian funds (e.g. a foreign investor needs to hire a local legal representative and a local custodian and has to register himself with Brazilian securities and tax authorities, among other things);

2) The extremely high level of taxes, especially when compared to jurisdictions such as most of the Caribbean offshore financial centres, which do not impose tax on foreign investors investing in funds domiciled in such jurisdictions. These two factors taken together explain why the vast majority (if not all) of the investors in investment fund domiciled in Brazil (not including private equity funds, which have special tax treatment) are Brazilian local investors.

3) The existence of strict portfolio investment rules applicable to hedge funds. Until very recently, save for a few irrelevant exceptions, hedge funds were not allowed to invest in assets traded in offshore jurisdictions; they were each obligated to invest their respective portfolios in assets traded in the Brazilian local markets. In addition, numerous investment restrictions were (and continue to be) imposed by Brazilian hedge funds legislation, such as diversification requirements, limitations of private issuers debt instruments or bonds, prohibitions against investing in companies not listed in Brazilian stock exchanges and many others.

The factors described above resulted in Brazilian domiciled hedge funds being at a significant disadvantage when competing with funds established in other jurisdictions for investors around the globe.

These factors forced Brazilian asset managers to establish hedge funds in offshore jurisdictions, in addition to their hedge funds domiciled in Brazil. Currently most of the Brazilian hedge fund managers also manage hedge funds formed either in the Caribbean financial centres or other countries that offer similar structures and benefits.

Recently CVM (the Brazilian securities commission) enacted several changes to the regulations for investment funds in Brazil. One of the most important was the authorization for hedge funds to invest up to 20% of their respective portfolios in assets traded outside Brazil. At the same time CVM published a release informing the public that it intends to elevate such limit to 100% for hedge funds directed to "ultra-qualified" investors in the near future and such change is greatly anticipated by the managers.

These changes represent a great step forward in the development of Brazilian domiciled hedge funds and were exalted by the investment funds industry. They represent a clear benefit for investors in Brazilian hedge funds, since such funds will be able to access a much greater variety of assets and potentially diversify risks.

However, such changes alone are not sufficient to place the Brazilian domiciled hedge funds in a better competitive position for global investors. In order for this to be achieved there will need to be much greater changes to the tax regime for offshore investors and in the bureaucracy that such investors have to deal with.

It seems that those Brazilian hedge fund managers who wish to attract global investors will still need to structure hedge funds in other jurisdictions in addition to those domiciled in Brazil.

This article first appeared in the October 2007 issue of Cayman Finance Review.



1 All figures related to assets under management and growth of the Brazilian investment funds were sourced from Anbid at

2 All currency conversions used an exchange rate: US$ 1 = R$ 1,92540 as at June 30, 2007, sourced from Brazilian Central Bank (

3 ICI – Investment Company Institute (

4 The Over/SELIC rate is a daily interest rate indicator. It is the adjusted average rate of daily financing guaranteed by federal government securities, calculated in the Special Settlement and Custody System (SELIC) and published by the Central Bank of Brazil (

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Bryan Hunter
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