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Sovereign Debt Fund

Sovereign Debt Fund

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1. What is it?

Sovereign debt funds aim to invest in Brazilian bonds traded in the international market. This type of fund represents the easiest, fastest and most practical way for the common investor to trade in this type of bond. Some sovereign debt bonds can only be acquired by funds like this.

To be considered a sovereign debt fund, a minimum of 80% of its portfolio must be invested in sovereign debt bonds, to be held abroad, in a custody account registered to the fund. The remaining 20% may be invested in other such credit bonds traded in the international market. Derivatives – including Brazilian derivatives – may be used for hedging, but not for leveraging.

No more than 10$ of the portfolio can be destined to international bonds issued by a same institution – or by companies controlled by the same institution. Investing in Brazilian market bonds is also prohibited, except if they are derivatives.

For the small size investor sovereign debt funds are an agile and low cost way of investing in Brazilian government bonds traded abroad. They represent an alternative to the traditional forex fund because they suffer less pressure from the Dollar fluctuation: when the Dollar falls, sovereign debt bonds tend to rise, and vice-versa. So this type of fund tends to profit less than forex funds.

Since dealing with internationally traded bonds, profitability on sovereign debt funds will be determined by 3 main variants: interest rates payable, performance of the bond abroad and the Dollar-Real exchange rates. Most bonds pay interest bonuses every six months. The country risk is also a determining factor, since an improvement in this rate will cause the bond to increase in value. The dollar is also established for the performance of profitability, as an appreciation in the dollar, for example, can bring greater gains. In other hand, a fall in the dollar could bring a lower profitability and even losses.

The greatest risk for this type of fund is Brazil’s possible inability to honor commitments. From this perspective, it should be a low risk investment. There are, however, other factors to account: a worsening Brazil risk perception would cause a fall, since quotas are marked-to-market. Dollar variations may also have a grave impact, since the local investor would count their profits in Reals, not Dollars. Both factors together, however, hold a negative correlation: crisis tend to cause Dollar rises, while betterments in perception will cause the rise in the bond values. So most funds will not suffer great fluctuations.

This is a small amount investment option, with an initial requirement of only R$ 1,000.00.


2. Taxation

Taxation on sovereign debt funds follows the same patterns as the burden on short term funds. Short terms funds are those with an average term equal or smaller than 365 days – or one year. For these funds income tax follows the table below:

  • Investments for up to 180 days: 22.5% (only over profits)
  • Investments between 181 and 360 days: 20% (only over profits)

Tax over financial operations, or IOF, also burdens all redemptions made up to 30 days from the date of investment. Investments lasting over 30 days are not burdened by the IOF. Rates applicable follow the table below:

Number of days from the investment date

Pro-rata tax incidence over profits (%)

1 96
2 93
3 90
4 86
5 83
6 80
7 76
8 73
9 70
10 66
11 63
12 60
13 56
14 53
15 50
16 46
17 43
18 40
19 36
20 33
21 30
22 26
23 23
24 20
25 16
26 13
27 10
28 6
29 3
30 0

The income tax due will be charged according to a daily verification of profits – and the payment will always be withheld by the fund, so the investor needn’t worry about particularities. Payment will be provisioned by the administrator inside the quota holder account – this means the fund will make a daily verification of profits and reserve the corresponding amount in income tax on the side. This reserve will be deduced from total quota values, directly reducing the total number of quotas held should the holder wish to redeem total or part of it. A reduction will also be made on the two tax payment dates set by the government: the last day of both November and May, each year. This process of “eating” part of the quotas held by an investor to satisfy income tax payments is what’s known as Quota-eating.

For long term investments, quota-eating rates are 15%. For short term, rates are 20%


3. Advantages

  • An easy and practical way of investing in Brazilian bonds traded in the international market
  • This type of fund doesn’t require large amount investments
  • Profits are usually paid every six months
  • Good diversification option.

4. Disadvantages

  • Investment funds are not guaranteed by the Credit Guarantee Fund
  • High administrative fees may affect profitability.
  • Moderate risk, considering sovereign debt funds are subject to the perception of the country risk as well as to currency fluctuations.

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