Accustomed to the constant and smooth appreciation of the CDI, many investors have recently become more anxious about the performance of various bonds and fixed income funds. The insecurity about the investment decision occurs because of the recent volatility in interest rates that impacted the price of bonds and fixed income funds referenced to the IPCA and prefixed. However, the source of the problem is the way of evaluating returns and risk.
For example, those who invested in the IPCA+2029 Treasury bond a year ago obtained a return of 7.64% per year. In the same period, the CDI appreciated 12.2% per year.
Perhaps the investor in this public bond is, at this moment, questioning whether it was a good investment, as its yield was only 62.7% of the CDI. Possibly, he reflects: “this was a bad investment, because I earned less and took more risk”.
However, this conclusion is not appropriate. The problem lies in the way of evaluating.
First, let's talk about risk.
We usually attribute greater risk to the greater volatility of an investment's returns. However, when we talk about fixed income, this measure should be used over the investment horizon.
Remember, risk is defined as uncertainty about future returns.
Therefore, which investment has greater risk, the one in which you are more certain of how much it will yield in the future or the one with less conviction?
We believe that the CDI has less risk, simply because investments fluctuate less with it. However, the certainty about how much the CDI's accumulated return will be over the next three to five years is lower than with any of the other fixed income indexes.
For example, which accumulated return over 3 years do you think is easier to predict: IPCA+6% per year or 100% of the CDI?
Without a doubt, forecasting about the CDI is much more difficult. In addition to having to assume how much the IPCA will vary, you also have to predict how much the CDI will gain from the IPCA. In the case of the title at IPCA+6% per year, you only need to predict the IPCA.
Therefore, the CDI is an indicator that carries much greater risk when the investment is medium and long term.
In the same way that the risk of a fixed income security must be measured over its horizon, so must the return.
For example, the investor who invested last year in the IPCA+2029 Treasury bond may be upset with his investment when comparing the return of the last 12 months with the CDI. However, the greatest probability is that it will be a better investment than the CDI if maintained until 2029.
Over the last 15 years, the CDI yielded an average of IPCA+2.4% per year. Therefore, if you purchased the IPCA+2029 Treasury bond last year, you locked in a return of IPCA+5.7% per year until 2029. Therefore, the greater probability is that you will have a greater result.
Another important example to mention is the case of IMAB-5. It is the index of federal public bonds with less than 5 years to maturity. The average maturity period of its bonds is around 3 years. Therefore, the appropriate window to evaluate your return should be 3 years.
The graph above shows how the IMAB-5 performed relative to the CDI over the last 20 years when analyzing 3-year investment periods.
In 90% of observation windows, IMAB-5 beat CDI. The average gain in the 3-year windows was 128% of the CDI.
Notice in the graph that we are experiencing the worst relative performance of IMAB-5. These moments of worst performance, in addition to being rare, usually last for a short time. Mainly, considering the direction of fall of the CDI and Selic in the future.
Therefore, be careful in evaluating the performance and risk of your bond or fixed income fund in the recent past. This analysis can lead to a wrong decision about the asset that should present the best return and lowest risk for you.
Michael Viriato is an investment advisor and founding partner of Casa do Investidor.
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