Trends in the Investment Fund Industry in Brazil

In recent years, the investment fund industry in Brazil has experienced a significant period of evolution, marked by the implementation of the CVM Resolution 175. This new regulatory framework represents a substantial advance, modernising, consolidating and standardising the regulation of all types of investment funds. The Resolution also regulates concepts introduced by the Economic Freedom Law, which for the first time added a specific chapter to the Brazilian Civil Code to address the legal regime applicable to investment funds.

CVM Resolution 175 not only consolidates the rules for all investment funds, but also incorporates the latest understandings of the CVM, providing greater consistency and legal certainty for the industry. This new regulatory framework makes the Brazilian market more flexible and modern, in alignment with international practices observed in more developed markets. The implementation of this regulation was a careful process, involving months of review and discussion with market participants. Effective from April 2023, following several postponements due to its significant impact, all investment funds in Brazil must comply with these new rules by June 2025.

The adoption of a more modern set of rules comes at a critical moment. In a macroeconomic environment characterised by high interest rates and inflation, the modernisation of the regulatory framework favours those who dare to innovate in a more challenging and volatile scenario. The flexibility and refinement of the rules allow fund managers to structure more sophisticated and adaptable products, enabling better navigation in this demanding landscape while seeking greater diversification and better returns for investors. This adaptability is also crucial as it allows fund managers to respond swiftly to market changes, ensuring that they can capitalise on emerging opportunities and mitigate potential risks.

Moreover, the new regulation aims to democratise access to more sophisticated investments, which traditionally were accessible only to institutional or high net worth investors. With CVM Resolution 175, more investors are expected to have the opportunity to access products with higher return potential, reflecting the growing maturity and evolution of the Brazilian investment market. The rule also enhances transparency, particularly regarding the allocation of economic incentives among different fund service providers, a movement aimed at strengthening cost comparability and investor trust. Enhanced transparency is anticipated to build greater investor confidence, encouraging more participation in the market and fostering a culture of informed investment decisions.

On the tax front, two recent developments have had a significant impact on the Brazilian fund industry. First, the conclusion of discussions related to the tax exemption structure for foreign investors in private equity funds brought greater clarity and legal certainty to attract international capital. Second, the tax reform of investment funds, embodied in Provisional Measure 1137/2022 and Law 14,711, was crucial to adjusting tax practices to the industry's new context. These measures are seen as essential steps toward increasing the competitiveness of the Brazilian market, making it more attractive to global investors and potentially leading to a greater influx of international capital that can drive further growth and innovation for the country.

Also on the tax front, Law 14,754 promoted significant changes to the taxation of closed-ended investment funds in Brazil for individuals and local entities, subjecting certain funds to semi-annual mandatory income taxation (so-called come cotas). Although this taxation regime already applied to open-ended funds, the extension to closed-ended funds resulted in a significant change in the credit funds industry landscape. Fixed income and multi-market funds typically used as investment vehicles for such strategy are now subject to this semi-annual taxation, shifting the focus of this segment of the industry to other types of funds subject to less stringent requirements, such as receivables investment funds (FIDC).

In addition to these regulatory and fiscal changes, the macroeconomic environment is also playing an important role in the structuring and fundraising of new funds in Brazil. Interest rates were raised substantially by the Brazilian Central Bank in the last three years in an effort to curb inflation, following a few years of mid to relatively low interest rates. This shift in interest rates has had a profound impact on investors’ behaviour, driving a preference for credit funds that offer more stable returns in a high-interest environment.

Whereas traditional credit strategies remain a popular choice for mutual fund managers, many managers are looking to private debt platforms as value-creating alternatives, resulting in new credit fund structures emerging as trends in the Brazilian industry. One of them is the structuring of high-yield and high-grade credit funds with a more sophisticated and innovative approach.

• High-grade funds, typically aimed at retail investors, now have advanced liquidity control mechanisms, including specific intervals for redemptions and pre-authorised side pocket structures, giving managers more control over capital management and, accordingly, the ability to invest in more illiquid (and potentially higher average returns) credit assets.
• High-yield funds, usually intended for qualified investors, are being structured as receivables funds (FIDC), as mentioned above, allowing investments in more complex assets with greater return potential and tax efficiency. These funds can also issue different types of quotas, also attracting mezzanine and subordinated investors.

In addition, current market conditions and regulatory developments are driving discussions and the structuring of Brazil’s first “evergreen” credit funds. These funds have an indefinite term and allow for the continuous reinvestment of assets, offering additional flexibility in portfolio management. This continuous reinvestment capability is particularly advantageous in a volatile market, as it allows fund managers to maintain a dynamic and responsive investment strategy.

New structures for special situations investment strategies have also gained prominence, reflecting the search for opportunities in a challenging market environment. These structures combine various funds and investment strategies under the same aggregator, including private equity, credit, distressed assets, and real estate, providing managers with a diversified and flexible approach to capital allocation. This flexibility allows for a more agile response to market opportunities and challenges, while ensuring tax efficiency for investors: the aggregator, generally a multi-market fund that is required to invest at least 95% in certain eligible funds, is usually exempt from the semi-annual taxation.

Another important trend is the growth of environmental asset funds, such as carbon credits, reforestation, and forest regeneration. These funds attract both local and international investors seeking to align their investments with sustainable and socially responsible practices. The increasing focus on sustainability is not only a response to investors’ demand but also reflects a broader global movement towards responsible investing, which prioritises long-term environmental and social impact alongside financial returns.

Additionally, regulation of agricultural- and real-estate-backed securitisation titles (tax exempt securities for individuals) was recently modified, reducing the list of eligible issuers, such as publicly-listed companies not directly engaged in the agriculture or real estate segment. These restrictions led to a reduction in the offering of such tax-exempt securitisation titles, which in turn is expected to potentialise the demand for tax exempt securities to infrastructure funds and other infrastructure securities. This shift underscores the dynamic nature of the investment landscape in Brazil, where regulatory changes can significantly influence investors’ preferences and market trends.

This trend is especially relevant given that the country faces a chronic gap in infrastructure financing, as public resources are insufficient to meet the growing demand for quality and sustainable services. To overcome this challenge, the aim is to attract more private investment, which can bring innovation, efficiency and risk-sharing to the sector.

Law 14,801 and government regulation modified the rules applicable to private equity infrastructure funds, among other changes, clarifying and expanding the list of segments into which such funds can invest – such as public transportation, public education, public health, mining of strategic minerals, among others. Funds that invest in more traditional infrastructure segments have also seen a resurgence of funding, both as a result of recent privatisations and public procurements carried by the government, as well as private interest to invest in trending segments, such as energy transition. Funds focused on the latter have seen a significant inflow of both national and international investments, given Brazil’s unique position as one of the world’s leading countries in the use of renewable energy sources while it still has a large untapped potential in this area.

Finally, the use of leverage structures in funds through redeemable preferred shares has become increasingly common in recent months. After years of discussion, the Brazilian market has begun to adopt these structures, allowing funds to leverage capital for cash management, asset acquisition, or early exits. This evolution is particularly relevant in a context where private equity funds face challenges in raising capital and executing exits, providing fund managers with additional tools to enhance returns and manage liquidity more effectively. The development of these strategies, enabled by the modernisation of regulations, has helped make the Brazilian fund industry more sophisticated, dynamic, and competitive.

Conclusion

The investment fund industry in Brazil is undergoing a profound transformation, driven by a combination of regulatory and fiscal advances, as well as a focus on innovation. CVM Resolution 175 and recent tax changes have created an environment that promotes diversification and sophistication of products offered in the Brazilian market, aligning it with global best practices. By providing a modern, flexible, and transparent regulatory framework, Brazil is positioning itself to attract both local and international investors seeking opportunities in a dynamic and growing market.

Brazilian fund managers have demonstrated a remarkable ability to adapt to this landscape, developing innovative structures using the new tools provided by the updated rules. This dynamism, combined with a more solid regulatory environment, offers investors a diversified range of options capable of meeting different profiles and investment strategies.

Despite the challenges, Brazil’s large and growing middle class represents a significant pool of potential investors. As more individuals seek to invest their savings and build wealth, the demand for investment products is expected to increase. This presents an opportunity for fund managers to develop innovative products and services that cater to the needs of retail investors. In this sense, the growth of the digital economy and technological advancements also present opportunities for the investment fund industry. With over 150 million internet users and a high smartphone penetration rate, digital platforms have become essential for reaching potential investors. Digital platforms and fintech solutions have democratised access to financial products, making investment products more accessible, efficient, and transparent. Embracing digital transformation can help the industry reach a broader audience, which is shown by the steadily increasing number of retail investors in the Brazilian investment funds industry. This digital transformation not only broadens the investor base but also allows fund managers to offer more tailored, innovative, and efficient investment solutions, thereby fostering a more inclusive and dynamic investment environment, improving the overall investor experience.

In a global scenario marked by uncertainty and volatility, the Brazilian fund industry stands out as a resilient and evolving sector. The country is uniquely positioned to become a reference in financial innovation and sustainable investment, contributing to economic development and the creation of long-term value. As the industry continues to transform, the opportunities ahead are promising, signalling a robust and vibrant future for the investment fund market in Brazil.