As Dalio Dances Dangerously With Brazil, Chanos Smiles

One country, two hedge fund legends -- two starkly different investment viewpoints. That is perhaps the best way to characterize Brazil, Bridgewater Associates and Kynikos. Brazil is Latin America's largest economy and the "B" in the ubiquitous BRIC acronym. Ray Dalio's Bridgewater is the world's largest hedge fund with $130 billion in assets under management. Kynikos has risen to prominence through the short-selling acumen of founder and President Jim Chanos. To say the two hedge fund luminaries have differing outlooks on Brazil is stating the obvious. Earlier this month at the Ira Sohn Conference in London,

"is rich in resources, but not rich." On the other hand, recent 13F filing data indicate that Dalio is a Brazil bull. Bridgewater initiated a position in the iShares MSCI Brazil Index Fund

, the largest Brazil-specific ETF,

. EWZ, which has nearly $8.8 billion in assets under management, devotes over a quarter of its weight to various securities issued by Petrobras

and Vale

. The former is Brazil state-run oil firm while the latter is the world's largest iron ore producer. Whether investors like it or not, the weight EWZ devotes to those Petrobras and Vale issues means a bullish bet on the ETF is bullish bet on those stocks.

That is a bet that has not paid off this year. Vale's U.S.-listed shares have slid almost 16 percent while Petrobras has plunged nearly 26 percent. Over the past year, both stocks are down and over the past five years, Petrobras has lost half its value while is up less than two percent. Besides weak returns, the two titans of Brazil's energy and materials sectors have something else in common. Chanos called the stocks two of his favorite shorts. Said another way, Chanos has overtly said he is betting Petrobras and Vale will decline. By virtue of Bridgewater's stake in EWZ, Dalio needs those stocks to rise in order to extract a decent profit from what is now

. Maybe Bridgewater is starting to see the writing on the wall when it comes to Brazil's economic struggles this year. The hedge fund pared its EWZ stake by almost 850,000 shares during the third quarter to bring its position in the ETF to just over 1.15 million shares at the end of September. There is also a fair chance Bridgewater took some losses on the liquidated shares because EWZ did not spend much time trading above $56 in the third quarter. In fact, the ETF closed above $56 just six times during the quarter and those instances occurred in succession from September 13 through September 20. Without knowing exactly when Kynikos initiated short positions in Petrobras and Vale, it is hard to say if the firm is in the green. However, if the hedge fund started those positions in the late second quarter, it should be noted both stocks are down more than six percent since then. In the past 90 days, Vale is up 9.6 percent, but Petrobras has slid 13.4 percent. To the naked eye, it would appear that Bridgewater has reduced its exposure to Brazil.

However, Bridgewater may have reduced its EWZ position in the third quarter, but it did not significantly reduce its exposure to Brazil. That is because the hedge fund boosted its stake in the Vanguard MSCI Emerging Markets ETF

by nearly 10.5 million shares during the third quarter to take the firm's interest in the largest emerging markets ETF to almost 49.3 million shares. The firm also added 1.6 million shares of VWO's primary rival, the iShares MSCI Emerging Markets Index Fund

. At the end of the quarter, Bridgewater owned more than 33 million shares of EEM. EEM and VWO both track the MSCI Emerging Markets Index, which does not exactly skimp on its Brazil exposure. At the end of the September, EEM had an allocation of 12.6 percent to Brazil,

. At the end of October, VWO's weight to the country was 12.5 percent,

. Petrobras and Vale are top-10 holdings in both ETFs. So although Bridgewater pared its exposure to those stocks by parting ways with part of its EWZ position, that trimming was somewhat muted by adding to EEM and VWO. There is more. In what was one of the biggest ETF stories of the year, Vanguard announced in October that it will drop MSCI indexes on 22 of its ETFs. VWO is one of those funds. Vanguard, the third-largest U.S. ETF sponsor, will transition VWO over to the FTSE Emerging Markets Index next year. The difference between the FTSE and MSCI indexes that the media and many investors have focused on is that MSCI views South Korea as an emerging market while FTSE does not. Bridgewater, if it was looking to dodge Brazil, should note that VWO's exposure to Brazil will increase when it transitions to the FTSE index. As of the end of October, the FTSE Emerging Markets Index

of its weight to the country. At 17.72 percent, only China has a larger weight than Brazil in the FTSE index. China accounts for 18.5 percent of the MSCI Emerging Markets Index. The China exposure is important because the country is Brazil's biggest trading partner. It has been weakness, perceived or real, in Chinese commodities demand that has weighed on Vale and other Brazilian materials names this year. Simply put, Bridgewater reduced its position in EWZ, but by increasing its bets on EEM and VWO, the fund is not skirting Brazil, nor China. Of course, Chanos is perhaps one of the most noted China bears out there. For more on ETFs, click

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