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.


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.

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Walter Stuber
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