Brazil: The Exchange Traded Funds In Brazil

Last Updated: 13 October 2009
Article by Walter Stuber

The Exchange Traded Fund (ETF), also known as tracker, is an example of a rapid success story in the international market1. This vehicle combines the diversification of a mutual fund with the flexibility of a stock. In Brazil an ETF (Fundo de Índice Negociado, in Portuguese) is an investment fund constituted under the applicable regulations of the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM), i.e. CVM Instruction No. 359, of January 22, 20022. A Brazilian ETF is structured as an open-ended fund, with units (quotas) traded on the stock market. An ETF is authorized for trading at BM&FBOVESPA (the main Brazilian Stock Exchange) like any other stock3, and its objective is to track the performance of a specific market index4.

To this end, the ETF´s portfolio replicates the composition of its reference index in accordance with certain rules set forth by the applicable regulations in force which establishes the portfolio´s minimum limits of exposure to the securities that form its underlying index. Generally, in order to request the creation of a new ETF, the investor must deposit with the fund manager, via an authorized agent, one or more creation quotas composed by the fund´s basket of stocks (the portfolio). The composition of each portfolio must be as follows: (i) at least 95% of the total value of the portfolio, by stocks that make up the underlying index; and (ii) at most 5% of remaining value, by other permitted investments such as government bonds, banking certificates of deposit (CDBs), investment funds quotes, repos, stocks that do not make up the index and cash.

The parties involved in ETF transactions are the following: (i) the Stock Exchanges (in Brazil - BM&FBOVESPA) – which provides a platform for the listing, trading, settlement and custody of ETFs; (ii) fund portfolio managers – they are responsible for managing the fund´s portfolio and for replicating the performance of the underlying index; (iii) the fund managers – they are responsible for managing the fund and for creating/redeeming ETF quotas; (iv) authorized agents – the brokerage houses that create and redeem ETF quotas and maintain a direct relationship with the fund manager; (v) market makers – the brokerage houses that are continuously present in the market by providing bids and asks for at least a minimum lot of ETFs per bid/ask, subject to a certain maximum spread5; and (vi) custodians – they ensure the safekeeping of ETFs and ETF component securities, as well as provide for the creation and redemption of ETF quotas.

On December 2, 2008, Barclays Global Investors (BGI), one of the world´s largest asset managers and ETF providers, launched in Brazil a family of three IShares Index Funds, which are the first ETFs approved by CVM, with initial portfolios totaling about R$ 100 million in assets. All these funds are managed by Banco Barclays S.A. (the fund manager) and track three different indexes: (i) the Bovespa Index (IBovespa), which holds the 66 most-traded stocks on BM&FBOVESPA; (ii) the BM&F Bovespa Mid-Large Cap Index, which holds 69 stocks representing the top 85% of the market capitalization on the São Paulo Exchange (adjusted for liquidity); and (iii) the BM&F Small Cap Index, which holds 71 companies representing the bottom 15% of the exchange´s market cap.

The ETF reflects the changes in its underlying index portfolio. Whenever such index is rebalanced based on the 4-month re-compositions the manager will adjust the fund´s investment portfolio so as to reflect the composition of the rebalanced underlying index. The fund manager will also adjust the composition to the fund´s portfolio upon distribution of corporate actions on the part of the companies that make up the underlying index.

The reference value for an ETF, also known as Indicative Optimized Portfolio Value (IOPV), is an estimate of the theoretical value of the ETF at a given time. The IOPV corresponds to the total value of all the component stocks of the ETF portfolio, updated by the most recent market price for those stocks, and dividing that total value by the number of quotas. The trading price of an ETF may differ from its reference value. It is expected that such trading price will vary according to the supply and demand, the existing market conditions, the potential performance of the stocks that constitute the ETF, the confidence of the investors and their expectations in relation to the national and international economic conjuncture. In addition, the ETF creation and redemption mechanisms also aim to help maintain the trading price of ETFs in a similar level as their reference value. Then arbitrage opportunities will be generated and gains will be realized at no risk.

Regarding fees and expenses, an ETF will only be allowed to incur fees and expenses that are authorized under its rules, such as management fees, BM&FBOVESPA annual contributions, Exchange fees and commissions related to the fund´s transactions, expenses related to the custody and settlement of the fund´s stock transactions, service fees and expenses related to independent auditors.

There are various advantages in investing in an ETF instead of buying individual stocks namely:

  1. Agility And Efficiency – an ETF allows the participants (quotaholders) to invest in several major publicly-held corporations in Brazil with a single transaction. The fund manager will rebalance the composition of the ETF portfolio in order to reflect the changes in the composition of the corresponding underlying index without any additional action or investment on the part of the ETF quotaholders;
  2. Diversification – it is not necessary to buy securities of various companies, since the ETF´s underlying index is composed by stocks of several companies from different economic sectors;
  3. Low Cost – the ETF is a unique investment vehicle with a low management fee. Its investment objective is to reflect the performance of the underlying index without incurring in: (i) the respective operating expenses; (ii) the significant initial cash investment; and (iii) the constant responsibility of performing the necessary readjustments to enable each investor to individually replicate the performance of the underlying index;
  4. Trading – an ETF is listed and traded at BM&FBOVESPA and may be bought and sold like any Exchange-listed stock6; and
  5. Flexibility – an ETF provides investors with benefits that are not available to those in non-listed investment funds. In this regard, an ETF may be used by quotaholders as collateral for the transactions they carry at BM&FBOVESPA in the same manner as other stocks. Furthermore, both the ETF and the stocks that constitute its underlying index may be lent in market transactions, pursuant to the regulations set forth by CVM and BM&FBOVESPA.

The number of ETF quotas is not fixed and may either increase through the creation of new quotas or decrease through the redemption of the existing quotas. ETFs can only be created or redeemed by authorized agents in minimum quotas, or its multiples, and the quantity for each quota is established under the rules for each index fund. An ETF is redeemable upon the delivery, by the fund manager to the quotaholder, via an authorized agent, of the following assets: (i) a portfolio of stocks from the underlying index; and (ii) a cash amount in accordance with the fund´s rules, as the case may be. It is possible to create or redeem the stocks at any time, but only if the quotaholder owns ETFs in lots that are whole multiples of a creation/redemption quota.

The quotaholders may borrow the underlying index´s theoretical portfolio stocks that are held by the fund in order to exercise the stocks´ voting rights in the general meetings of the respective companies. The number of the stocks held by the fund that the quotaholder will be entitled to borrow will be directly proportional to the number of ETFs held by the quotaholder at the end of the day on which the borrowing request is made.

The minimum lot for trading ETFs on the secondary market7 generally refers to a round lot corresponding to 100 ETF quotas. Trades are done in round lots or in multiples of a round lot. The settlement of the ETF transactions traded in the Exchange in the secondary market follows the same settlement cycle as the stock transactions traded on the cash market, i.e. it takes place on the third business day after the trading day (T+3).

ETFs are not immune to risks, like any other investments in the financial market. The risks involved in ETF trading are the market risk and the tracking error.

When investing in an ETF, the investor becomes exposed to the market risk and to the volatility of the stocks that constitute its underlying index. Therefore, if market conditions are unfavorable, such as in a recession, or if the overall prices of stocks, securities and commodities fall, then the value of the ETF will fall in the same proportion. However, investing in an ETF will still provide returns that are close to those of the underlying index.

The tracking error is the risk that the ETF manager will fail to exactly replicate the performance of the underlying index. This risk results from the fact that the portfolio of an ETF is not exactly equal to the portfolio of its underlying index. Furthermore, certain factors like management fees and possible time discrepancies in the rebalancing of portfolios may reduce the returns of ETFs in relation to the returns of their underlying indexes.

Brazil is one of Latin America´s biggest fund markets and the BM&FVBOVESPA´s profile as a major global Exchange has been raised in the recent years. In addition, long-term prospects are very positive for Brazilian ETFs and the investors demand may lead to the creation of additional ETFs and indexes before year-end.

Footnotes

1. The first ETF was launched in 1989 in the United States to reflect the performance of the Standard & Poor´s index known as S&P500 index. At the American Stock Exchange and Philadelphia Stock Exchange, ETFs were traded under the name of Index Participation Shares. In the 90s, ETFs based on the TSE 35 and TSE 100 indexes were launched in Canada. In 1993, S&P launched its Depository Receipt (SPDR), known then as Spider. In 1996, Barclays Bank in the United Kingdom launched the World Equity Benchmark Shares (WEBS), which were later called iShares MSCI Index Fund Shares. Since that time, these new forms of investment have become ever more present in the world´s major financial marketplaces and now they are also available in Brazil.

2. CVM Instruction 359/2002, which deals with ETFs in Brazil, was formulated based on comparative studies of other countries, such as the United States, Canada, Germany and Hong Kong and taking into account the contributions from various institutions such as Morgan Stanley, Goldman Sachs, the Brazilian Economic and Social Development Bank (Banco Nacional do Desenvolvimento Econômico e Social – BNDES), the Brazilian Stock Exchange (BM&FBOVESPA) and the American Stock Exchange.

3. ETFs are listed in the Stock Exchange and can be traded at any time during the trading session, making it easier for investors to buy or sell them. As cash market products, stocks and ETFs utilize the same types of trading orders.

4. An índex is an indicator of the performance of a portfolio of stock (shares), securities or assets that is meant to represent a given market, sector or segment. An índex also serves as a thermometer for evaluating a group of shares over time.

5. The market makers play an important role in providing liquidity to the ETF market and the majority of them also act as authorized agents.

6. Before investing in a particular product (buying or selling quotas of an ETF or a stock), the investor must first become a customer of a brokerage house. For this purpose, investors must seek the advice of a BM&FBOVESPA brokerage house to receive assistance in selecting the best investment options based on their profile.

7. The primary market is where a creation order for new quotas or redemption of existing quotas is done directly with the fund manager through authorized agents. The secondary market refers to transactions for the purchase and sale of quotas done on the stock market.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Walter Stuber
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.