"Deep structural pessimism" - Pzena's hunting ground for great opportunities

Brazilian equities have staged a notable rebound in 2025, following a volatile 2024. The MSCI Brazil Index declined by 30% in 2024 after rising 14% and 33% in 2022 and 2023, respectively (Exhibit 1). Despite recent gains, Brazilian equities remain below pre-COVID levels, trading at valuations that imply deep structural pessimism.

Cumulative performance of the MSCI Brazil Index and MSCI Emerging Markets Index. Total return in USD, base value of 100, from 12/31/2019 – 6/30/2025. 

Despite this relatively benign economic backdrop, the pricing of Brazilian equities appears to reflect a negative outlook, with the drawdown largely driven by political concerns. Fears that President Lula could enact populist fiscal measures to counter declining approval ratings have weighed on valuations. As a result, Brazilian equities are cheaper now than they were during the early months of the COVID-19 pandemic, as well as the 2014-2016 recession (Exhibit 2).

The forward price-to-earnings ratio for Brazilian equities has averaged 7.4x for the past four years, which is more than a full standard deviation below their long-term average of 10.4x(1).

Source: FactSet, MSCI Chart depicts price to earnings (next twelve months). 

We added Ambev (BVMF: ABEV3), the largest brewer in Latin America and Canada, to our portfolio in 2020. At the time, the company faced beer volume declines amid COVID-19 restrictions. Although volumes have rebounded to record levels, Ambev has faced several macroeconomic challenges, including higher input costs due to a weak Brazilian real and commodity cost inflation. 

More recently, shares fell due to the earnings impact of the devaluation of the Argentine peso, as well as uncertainty surrounding Brazil’s new tax regime. Despite potential tax burdens, we believe the current share price more than discounts forthcoming changes, and we are optimistic about Ambev’s underlying business. 

We expect the company’s premiumization strategy will contribute to further margin expansion, as macroeconomic headwinds abate. 

We believe that Ambev’s earnings recovery implies it is trading at roughly 11x our estimate of its normal earnings power. 

We also added Vale (VALE), the Brazilian miner with best-in-class iron ore assets (by iron content), to the portfolio in the fourth quarter of 2023. More recently, concerns over global growth following a period of strong steel demand have weighed on shares, particularly due to Vale’s revenue exposure to China. Even factoring in a large decline in iron ore prices–and production figures below the company’s guidance–shares trade at an attractive valuation of approximately 6x our estimate of normalised earnings. Furthermore, two dam failures in Brazil in recent years have been an overhang on the stock. Vale has reached compensation agreements with the government for communities impacted by the two failures. 

We believe that Vale has improved its governance in the intervening period, and the company has begun to revamp its sites in order to meet new regulatory standards. 

When we added Banco do Brasil (BVMF: BBAS3) to the portfolio in 2023, the share price reflected deep fears of government intervention under President Lula’s administration, reminiscent of the policies during Dilma Rousseff’s presidency. However, using Banco do Brasil as a vehicle for fiscal stimulus would generate negative political headlines for an administration already facing pressure; we therefore view the likelihood as low. At a company-specific level, asset quality is expected to improve, and non-performing loan (NPL) formation within the bank’s agricultural lending portfolio is expected to decline following the 2024/2025 soybean harvesting season, given strong volumes and improving market prices. 

Additionally, the company offers one of the highest returns on equity among Brazil’s largest banks, and we view the current valuation of 5x our normal earnings estimate to be compelling. 

Another financial portfolio holding is Itaú Unibanco (BVMF: ITUB4), which was added in 2020. We own Itaú for its consistent execution, strong balance sheet, and ability to deliver high-quality earnings through cycles. Since our initial investment, Itaú has actively de-risked its retail lending book and prioritised higher-quality borrowers - managing credit normalisation better than peers. This discipline, along with strong cost control and growing fee-based income, has supported resilient performance despite concerns over the macro environment in recent years. Itaú now carries excess capital, which has enabled elevated shareholder distributions through buybacks and special dividends. 

Loan growth has been muted, reflecting its deliberate focus on credit quality and risk-adjusted returns. In a market where many financials remain sensitive to credit volatility and capital constraints, we have confidence that Itaú could weather a prospective downturn due to its high provisioning coverage and strong capital ratio. 

On the capital side, Itau has seen a minimal impact from recently introduced accounting changes in Brazil. As a result, we believe Itaú is in a position to return capital to shareholders, and shares currently trade at 8x our normal earnings estimate. We continue to find leading Brazilian companies that we believe are particularly cheap, and over time, we have steadily increased our exposure as a result (Exhibit 3). 

Source: FactSet, MSCI Pzena Emerging Markets Focused Value Composite estimate; relative Brazil weight versus MSCI EM Index. 

We remain focused on investing in companies whose valuations we believe have been unduly punished because of temporary macro concerns, political fears, and company-specific controversies.