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Variable income fund

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1. What is it?

Variable income funds, stock funds or equity funds (as they’re usually called) must invest a minimum of 67% of their portfolio in stock, DRs, subscription bonuses or receipts, stock certificates, shares of stock investment funds, shares of index and stock funds and BDRs – Brazilian Depositary Receipts, provided these bonds are admitted and traded in the stock exchange or over the counter (CETIP).

The rest of the equity that exceeds the minimum percentage of 67% may be applied to any other form of financial assets, since the boundaries will be respected by the securities issuer and are considered the concentration limits by type of financial asset established in CVM Instruction 409 and 450. These assets can be public or private bonds, and other fixed income securities or other modalities.

Strategies for this type of fund may vary. As a practical example, a few can be mentioned:

Following an index

Some equity funds aim to follow or surpass a specific index (Ibovespa or IBRX, as exampel) as their investment strategy. For funds that simply aim to follow an index, leveraging is forbidden. For those focused on surpassing it, leveraging is allowed.

Corporate governance

This type of fund will invest in the companies with the greatest practices in corporate governance. Companies chosen as investment must be listed in the New Market or classified as level 1 or 2 in the Brazilian Stock Exchange (BM&F/BOVESPA). These funds only select companies with the highest possible management and transparency practices when dealing with an investor: all stock holders are treated in the exact same manner, thus helping elevate safety when releasing information to the market.

Dividends

This strategy focuses on adding to the portfolio stocks with a high dividend yield factor, or that are expected to develop one momentarily. In most cases, this means mature companies that don’t require short term investments, being able to offer a better profit distribution to their shareholders. In this type of fund, some double taxation may occur: dividends are burdened by income tax withholding and, if delivered directly to the shareholder, tax is paid only in this fashion. However, once the fund incorporates those dividends that have already been taxed into the fund’s quotas, a new tax will be due once a quota redemption is made by the investor. Nonetheless, fund managers seem to think this double taxation has a very low impact over profits. Besides, dividends may also be used for the acquisition of new stock.

Small caps

This strategy focuses on investing in companies with low market capitalization, or those not necessarily listed in the main stock exchange indexes – but that show, however, a great potential for growth. These funds may be highly profitable according to the manager’s vision, provided this type of stock offer great potential of increment in the longer term.

Sustainability

In this strategy, the funds invest their resources in companies that have good sustainability practices. Managers choose companies that demonstrate commitment to sustainability, as well as aspects such as economic, financial, social and environmental. Nowadays, it is very common individuals and companies seek companies that invest in the sustainability of our planet. Even companies that have a bad image among investors, as the use of semi-slave labor, for example, may suffer declines in shares or profits because many investors care about these practices, and often fail to consume these products companies.

Market Timing

Market timing is the name given to the ideal moment to buy or sell a specific asset, thus increasing one’s potential profits. You can get above average profits in anticipation of market movements, buying cheap stocks with growth potential and other price distortions. Funds that have this as an investment strategy will many times use derivatives to leverage their position, with overwhelming results – both in profits, if they guess the market correctly, or in losses, if they don’t. If the market is falling and the manager thinks it will turn, anticipate the market by buying cheap stocks can be a good strategy, but many analists say it is difficult to predict when the market will change its trend.

Stock Picking

It is the choice of specific assets. It is betting on stocks with the highest potential return. If the manager of the fund chooses a stock with a high growth potential and are right in your analysis, it can make bigger profits, exceeding its benchmark. Generally, these funds are used for fundamental analysis to find stocks with high return potential. It is not easy work to find these stocks, where the manager will have to pan many stocks even find one that is worth buying.

Asset Location

Funds that base their investment strategy in asset location will focus on diversifying the portfolio by acquiring assets from a number of different market classes. Diversification will help lower the risk, especially considering different class assets will behave differently to market fluctuations. This strategy tends to lower volatility and risk.

Use of these market analysis strategies (asset location, market timing and stock picking) may help increase profits. These are, however, sophisticated analysis that have to be conducted by people with great training and experience, especially when dealing with longer term portfolios. A bit of luck will always help, as well.

Arbitration

This strategy consists of buying the same asset in different markets, aiming to profit from the price differences in those two circumstances. As a practical example, a fund could buy an ordinary share and sell a preference share from the same company at the same time. In this case, they’d be betting on the price difference between the assets. Another example would be the purchase of a public bond on a descending interest curve, when the fund’s quota is over-valued because of a lack of marking-to-market practices. Although today this represents a mandatory practice, some funds might still make use of this subterfuge.

Specific

This strategy consists of buying a single type of asset – from a specific sector, for instance – or focusing on the most traded stock in the Stock Exchange, like Petrobrás or Vale.

Undervalued stock

This strategy focuses on undervalued stock, or stock being traded on lower prices – simply because they’re low or, sometimes, being held below their fair value for some specific reason. A “fair value” is a calculation somewhat subjective and the object of great disagreement between market specialists. Basically, it would be calculated by trying to determine the company’s future cash flow balances based on a number of current premises and a basic expected increase rate. Once those values are calculated, a discount rate can be applied to find the current “fair value” of this company. This would, theoretically, take into account the potential of a company for trading in its stock today. However, as previously mentioned, some analysts will simply discard those types of calculation entirely.

Free trading

In this specific strategy, funds do not follow any set of rules – they keep 67% of their portfolio in the stock market, only. This allows them more freedom to invest wherever they choose.


2. Taxation

Equity funds are burdened by income tax at a rate of 15%, regardless of the duration of the investment. Tax will be withheld by the fund’s administrator and paid directly to the government, so the investor needn’t worry about this transaction. Payment will be withheld only upon redemption, and deposited by the third consecutive day after the redemption transaction is finished. For this type of fund, all income tax payments will be made, even if the redemption accounts for less than R$ 20 thousand, a minimum limit in other cases.

No tax over financial transactions will be charged, and no quota-eating will be conducted.


3. Advantages

  • Initial investment isn’t high;
  • Professional management may select the most profitable assets, not requiring profound study or analysis by the investor;
  • Not burdened by tax over financial transactions (IOF, in Portuguese);
  • No quota-eating processes;
  • Liquidity – making it possible, in some cases, to redeem and receive payment on the same day;
  • Diversification – the fund can acquire many more stocks than a personal investor, diversifying options for profit and reducing risk.

4. Disadvantages

  • Not guaranteed by the Credit Guarantee Fund;
  • High administrative fees may impact profitability;
  • High risk – variable income means facing the chance of losing all the money invested;
  • Burdened by income tax even if the redemption amounts to less than R$ 20 thousand (for direct stock market investments, redemptions under that limit aren’t taxable).

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