Political discord has resurfaced in Brazil, ensnaring President Michel Temer with claims of involvement in an illicit payoff scheme.

While this may trigger a sense of déjà vu, President Temer initially avoided any direct claims of impropriety in a sweeping probe that scandalised an entire class of politicians and business leaders in recent years. Now, he appears to have implicated himself in a recording allegedly depicting his approval of a massive hush money bribe.

Background

Brazil arguably represented one of the most attractive up-and-coming investment destinations in the world leading up to 2014. The B in the BRICS acronym used to reference the major emerging economies group that also includes, Russia, India, China and South Africa is a net oil producer with seemingly stable, if imperfect, institutions, rapid growth, and a relatively young population with a penchant for leap-frog-style modernization afforded by the mobile technology gains of recent years.

Then a heavy two-punch combo landed in 2014 from which Brazil has only recently begun to show signs of recovering. Global oil-supply gains went unrequited on the demand side, leading to deteriorating conditions for producers as energy prices began to slide in mid-2014.

Brazil’s Federal Police launched the “Operation Carwash” investigation around the same time, exposing a corrupt payment network at the high-level intersections of business and politics. So far, 179 indictments have been issued, with 93 convictions across 16 companies and the Brazilian government.

President Temer came to office in the wake of his predecessor’s impeachment and removal. He has already been subject to corruption claims prior to the latest allegations. Outside of Brazil, however, he was perceived as a potential catalyst for stability and reform in a country that desperately needed both.

Market Reaction

The latest accusations were not received well by investors: Brazilian stocks plunged on May 18, 2017—the day the recording’s existence was first alleged—with trading halted temporarily on the Bovespa (Brazilian stock exchange). The Ibovespa Index, which serves as a key measure of the Brazilian stock market, partially recovered, but still closed 8.8% lower on the day in price-return terms. Brazil’s currency, the Real, slid by 7.16% versus the U.S. dollar, and Brazilian sovereign bond yields spiked higher.

What’s Next?

Brazilian opposition parties have already filed an impeachment request and called for President Temer to resign. He has denied the accusation, promised to fight and ruled out resignation. Meanwhile, Brazil’s Supreme Court has authorised an investigation.

The next presidential election will take place in late 2018. If President Temer takes significant heat, but neither resigns nor suffers impeachment, then he will likely limp through the rest of his term as the country focuses on the next election.

Early elections are possible. Brazil’s electoral court was already scheduled to rule in early June on whether the 2014 presidential election should be invalidated on the grounds of illegal campaign contributions. If that comes to pass, Brazil’s constitution would require a new indirect presidential election within 30 days.

SEI’s View

The investor-friendly reform timetable will be set back by these revelations, but we believe there’s widespread acceptance within the Brazilian government that public spending needs an urgent fix. Pension reform is at the front of the line, and we see little reason to suspect that will change based on the latest allegation.

We believe the likelihood that President Temer will be followed by a serious reformist—if elected indirectly by Brazil’s Congress—is quite high, which bodes well for a continued move toward greater government spending control.

With respect to capital markets, it’s important to maintain context. The Ibovespa Index was approaching the upper end of its ten-year range when the latest allegation was levelled, having rallied a stunning 79.4% over the last 16 months. The May 18 decline was indeed sharp, but there was no follow through the next day as the Index rebounded by about 3% (as of noon ET). Similarly, the real recovered by about 2.5%.

We suspect the accusation against President Temer will prove to be a temporary impediment to Brazil’s continued recovery. Its investors have weathered worse over the last three years, and even his  premature departure from office could lead to a positive outcome in a more favourable replacement.

As such, the recent selloff and others that may materialise as the story unfolds could prove to be buying opportunities.

Our Funds

SEI’s positioning within Brazil is mixed. As Exhibit 1 depicts below, we have notable overweights in our multi-asset income fund (which has a naïve benchmark that doesn’t reflect our long-term strategic emerging-market allocations), and our emerging-markets equity fund. Our emerging-markets debt fund has a significant underweight.

Most of our funds with exposures to Brazil, however, are close to benchmark weight (+/- 50 basis points).

Glossary

Basis point: 100 basis points equals one percent.

Important Information

Past performance is not a guarantee of future performance.

Investments in SEI Funds are generally medium to long term investments. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. Additionally, this investment may not be suitable for everyone. If you should have any doubt whether it is suitable for you, you should obtain expert advice.

No offer of any security is made hereby. Recipients of this information who intend to apply for shares in any SEI Fund are reminded that any such application may be made solely on the basis of the information contained in the Prospectus. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

In addition to the normal risks associated with equity investing, international investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Bonds and bond funds are subject to interest rate risk and will decline in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments. Narrowly focused investments and smaller companies typically exhibit higher volatility. SEI Funds may use derivative instruments such as futures, forwards, options, swaps, contracts for differences, credit derivatives, caps, floors and currency forward contracts. These instruments may be used for hedging purposes and/or investment purposes.

While considerable care has been taken to ensure the information contained within this document is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.

This information is issued by SEI Investments (Europe) Limited, 1^st Floor, Alphabeta, 14-18 Finsbury Square, London EC2A 1BR which is authorised and regulated by the Financial Conduct Authority. Please refer to our latest Full Prospectus (which includes information in relation to the use of derivatives and the risks associated with the use of derivative instruments), Key Investor Information Documents and latest Annual or Semi-Annual Reports for more information on our funds. This information can be obtained by contacting your Financial Advisor or using the contact details shown above.

SEI sources data directly from Factset, Lipper, and BlackRock.