By David Waring on Mar 15, 2013 04:46:54 GMT

Anyone looking to invest in emerging markets, would be hard pressed to ignore Brazil. With a young dynamic population, vast reserves of commodities, millions of acres of farmland and a thriving diverse economy, it’s not hard to see why the Brazilian Economy offers so much promise.

But investing in Brazil is not without risk, growth has slowed recently to just above 1%, largely due to a slowdown in the Chinese market. Inflation is also on the rise and company profits are falling. But if you know where to look, Brazil still offers some amazing opportunities.

Christ the Redeemer Statue Rio de Jeneiro

Opportunities for Growth

The days of investing in the Brazilian economy as a whole and expecting a return, may be over. But if you tread carefully, there is still some money to be made.

As with most developing economies, Brazil’s infrastructure is well behind other more developed nations. Their road networks, sewage systems, hospitals and airports are all in desperate need of investment.

But unlike other developing economies, Brazil is actively doing something about it. Largely spurred on by the upcoming, soccer world cup in 2014 and the Olympics in 2016. Up to US$1 trillion is due to be invested in Brazilian infrastructure projects within the next ten years.

Brazil is financing the majority of this development through private equity funds. These funds have been made particularly attractive to foreign investors through the use of (Fundos de Investimento em Participações – FIPs).

FIPs are closed-end investment funds that can acquire shares, debentures, subscription bonds, convertible securities and derivatives of any Brazilian publicly or privately traded company. They’re restricted, though, from acquiring real property, may not acquire shares issued by the administrator and cannot invest abroad.

Key incentives for overseas investors in FIPs include:

Income and capital gains received by the funds are not subject to taxation in Brazil. There is no withholding tax on disposal of FIP quotas for foriegners as long as they are not located in a low tax jurisdiction (defined as where income is taxed at less than 20 percent and/or where there are restrictions on disclosure of shareholder composition or beneficial ownership).

The Brazilian stock market

Foreign investors can buy stocks directly on the BM&FBOVESPA, Brazil’s main stock exchange. Investments by non-residents are not subject to withholding tax, however; you will be subject to the Imposto sobre Operações Financeiras, which is levied on the inflow of foreign investment into the stock market at a rate of 2%.

ADRs

American Depositary Receipts (ADRs) are Brazilian stocks listed directly on US exchanges. A sponsor bank simply buys a block of Brazilian company shares and relists then on the US market priced in US dollars.

ADRs offer a simple but effective way for smaller investors to invest directly in Brazilian stock. They’re available for all Brazils major corporations, including Petrobras SA (NYSE: PBR) and mining giant, Vale SA (NYSE: VALE).

You can find a full list of Brazilian ADRs here.

ETFs and Mutual Funds

ETFs offer investors an easy way into the Brazilian market, there are a huge number to choose from, giving you access to all sectors of the economy, including the booming infrastructure and small cap sector.

Exchange Traded Funds (ETFs)

iShares MSCI Brazil exchange-traded fund (NYSE:EWZ). This fund is very dependent on commodities – approximately 18% of the ETF is made up of Petrobras (NYSE:PBR) and 14% mining giant Vale (NYSE: VALE).

EGShares Brazil Infrastructure ETF (NYSE: BRXX). This fund includes stocks within the telecoms, utilities, and road building sectors.

WisdomTree Dreyfus Brazilian Real (NYSE: BZF). This fund seeks to achieve total returns reflective of both money market rates in Brazil available to foreign investors and changes in value of the Brazilian real relative to the U.S. dollar.

Mutual Funds

Fidelity Latin America (MUTF:FLATX). This fund normally invests at least 80% of assets in securities of Latin American issuers and other investments that are tied economically to Latin America.

T. Rowe Price Latin America Fund (MUTF:PRLAX). This fund invests at least 80% of net assets in Latin American companies. It invests in at least four countries represented in the funds portfolio and may purchase the stocks of companies of any size.

JPMorgan Latin America A (JLTAX). This fund invests at least 80% of assets in securities of Latin American issuers and other investments that are tied economically to Latin America.The minimum investment is $1000.

What Challenges Does Brazil Face?

Brazil is one of the top 10 fastest growing economies in the world and the largest economy in Latin America. Whilst they’ve taken a hit recently, due to the recession and subsequent slowdown in China. They’re still due to grow this year by around 1%.

Brazil enjoys a relatively stable macro-economy with both consumer and investor confidence remaining high. But it’s not without its problems, the chief of which is high inflation. Last year inflation was running at 6.15% which is well above the Governments target of 4.5%.

Efforts are being made to curb inflation, but to a large extent these are just superficial. They include, asking city governments to hold off raising bus fares and flagging tax cuts for basic foods. Economists have called these measures, “economic sticking plasters” rather than root and branch overhaul.

Focus should instead be put on measures to boost Brazils ability to supply goods. These include increasing factory output and productivity; encouraging investment in new business; and measures to increase foreign investment, which currently stands at half the level of China. All this would allow the economy to grow, without generating inflation.

So far only baby steps have been made by the government to tackle these reforms. There seems to be a reluctance to make more sweeping changes, but further steps are needed if they are to be truly successful and fix the inflation problem long term.

Whilst high inflation is a concern for foreign investors, it shouldn’t put you off investing in Brazil altogether. Once the world has fully recovered from recession, you can bet that Brazil will start advancing again quickly. Until then there is billions of dollars being spent on infrastructure, which not only means potential returns for you as an investor, but also puts Brazil in a much stronger position once the global economy improves and double digit growth returns.