By Katie Llanos-Small
A decade ago, administering a pension fund in Mexico was a
relative cinch. The recipe was straightforward: throw 85% of
your assets into government bonds, and go for lunch. It was an
easy decision for the fund managers. With investments in
equities, real estate funds, commodities and international debt
all banned, they had little choice.
Back then, the funds were already growing quickly. Indeed,
they had nearly tripled in size in three years. But at around
350 billion pesos in May 2003, the pension pot was not raising
Today, however, the stakes are higher. Mexico’s
pension funds have experienced a giddying rise in their asset
pools. Assets of the Afores, as Mexico’s pension
fund administrators are known, hit 2 trillion pesos ($164
billion) in March this year, twice the cash they looked after
just four years ago. The momentum shows no sign of slowing.
Mexico’s pension regulator, Consar, estimates the
country’s retirement funds will be looking after
close to 5 trillion pesos by 2019.
This exponential expansion has led to heady excitement. But
it also poses challenges for pension fund managers and their
regulator as they try to keep a handle on the ballooning assets
It is a phenomenon being repeated across Latin America. As
the region’s middle class booms, the benefits are
reaching many industries. Pension funds are one area seeing
particularly positive effects.
Youthful populations mean more people are starting work than
are hitting retirement age, pushing up the numbers of potential
pension fund contributors. And as a greater proportion enters
formal employment, potential contributors are becoming real
In the Andean region alone, assets under management more
than doubled between 2008 and 2012. Pension funds in Chile,
Colombia and Peru had $271 billion equivalent of assets at the
end of 2012, according to data from Strategic Insight, a
consultancy. That was $116 billion in 2008.
In sharp contrast to the mature pension funds in the
developed world, Latin America’s funds face unique
difficulties. The young populations are driving growth so
rapidly that the funds threaten to become unwieldy. In Peru and
Colombia, for example, pension fund assets equaled 17% of GDP
at the end of 2011, according to OECD figures. In Brazil they
were close to 14%, and in Chile, a whopping 58.5%.
With the pension systems in the region still a fairly new
phenomenon – Chile in 1981 pioneered the structure now
in place across most of the larger economies – worries
are emerging over how the mushrooming pools of assets should
best be managed and invested.
"The most pressing issue is related to guaranteeing this
growth of the system, the savings," says Carlos Ramírez,
head of Mexico’s pension regulator, Consar. "We
have to guarantee that this growth is followed by better asset
managers on the side of the Afores. They are managing almost
13% of GDP every single day. We need to guarantee that the
quality of the corporate governance of the Afores
Across Latin America’s biggest economies,
regulators are dealing with similar concerns. Part of the
solution, to varying degrees, is being found in giving the
pension funds greater freedom over where they can invest, and
allowing them to hand some control to third party managers.
Brazil’s pension funds, no longer able to rely
on the local market for the inflation beating returns they
target, are poised to contract international managers to look
offshore for better yields. Five Mexican funds are in the final
stages of signing off third party mandates with their
Peru’s regulator raised the cap on
international investment for the third time this year in April,
allowing funds to allocate as much as 36% of their portfolio
offshore. The two-point increase gave Peruvian pensions around
$775 million to send abroad – and increased the
opportunities for third party managers.
From August, the pension fund administrators – AFPs
– will also be able to invest in alternative
strategies, including infrastructure, private equity and hedge
As they loosen the rules, regulators are keeping a close eye
on the results, aware that they are entering, for them,
"The art is to find a way to manage a fund well, and also
with caution," says Daniel Schydlowsky, head of SBS,
Peru’s banking, insurance and private pension fund
"We face a big challenge, to define benchmarks for long term
investment in a growing economy where the retirement funds are
big players and therefore affect the market and the
economy´s rate of growth. No-one knows how to do this
perfectly. We’re on the frontier, looking at new
areas, and we have to proceed with caution."
Boasting the region’s most mature private
pension fund system, Chile offers a model for managers and
regulators in other jurisdictions.
One basic lesson has already been taken on board almost
everywhere: that a defined contribution, rather than defined
benefit, system eases the pressure on managers to hit lofty
return targets. Under defined contribution schemes,
retirees’ savings are the sum of what they put in
and the returns generated by the manager. Defined benefit
schemes guarantee a pension amount, such as a percentage of the
employee’s final salary.
Three of the largest markets – Colombia, Mexico and
Peru – have switched to the defined contribution
model. There, returns are encouraged through competitive
systems that take into account yields and management fees.
An outlier is Brazil, where some funds remain defined
benefit systems, guaranteeing savers a certain level of income
once they stop working. That creates a headache for the pension
administrators, who are forced to chase chunky returns above
Brazil’s already infamously high inflation
Compared globally, the country spends a lot on pensions
– especially since its workforce is young. The IMF
warned last year that Brazil’s pension system
faces a funding gap of as much as 25% of GDP on a net present
value basis over the next 20 years, as the population begins
Brazil is working on the problem: the largest defined
benefit schemes are closed to new participants, and the country
changed pension rules in 2003 and again in 2012. The regulator
has capped the yields pension funds can use in their
forecasting, and is winching it down.
But, moving from inflation plus 6% in 2012, to inflation
plus 4.5% in 2018, those yield targets are still tough. Latin
America’s largest fund, Previ’s Plano
1, which had 163.5 billion reais ($81.5 billion) of assets at
the end of 2012, is the most prominent fund exposed to the
Plano I’s investments yielded 12.63% last year,
more than a point above its inflation-plus-5% target. This
year, it plans to shift its allocation further away from fixed
income instruments, capping those securities at a third of the
portfolio. Still, meeting this year’s target in
the local market will not be easy.
"The interest rates in Brazil have declined very fast," says
Renê Sanda, CIO of Previ. "In 2013, for the first time,
if we invest in Brazilian bonds, we are not going to receive
interest that is enough to cover our actuarial rate. This is
the first year that has happened."
Among the countries with defined contribution systems, Chile
has led the way in another structural aspect.
"Chile opened the multifondos system, offering a series of
funds with different risk contexts," says Peter Wall, of
Wall’s Street Advisor Services. "The type A funds
have the largest allocation to equities and to foreign assets.
The most conservative funds, the E funds, have reduced limits
on exposure to risky assets."
That is reflected in the returns. Type A funds have posted
real returns of 6.9% a year on average between September 2002
and March 2013, according to Chile’s pension
regulator. Type Es returned 3.87% on average over the same
Peruvian funds see a similar trend. The most conservative
funds, known as Type 1s, averaged real returns of 5.86% over
the past seven years. The riskier Type 3s, meanwhile, have
average annual returns of 13.09%.
Other regulators are following Chile’s lead in
another area, too: allowing increasingly large investments
offshore. Chilean funds can allocate as much as 80% of their
cash outside of the country.
Regulators across the continent are giving pension
administrators greater freedom to invest internationally.
The idea is to diversify risk. But it is also a somewhat
counterintuitive move in today’s global economic
Latin America’s growth has outstripped that of
developed markets. Global asset managers are rushing into the
region, taking advantage of yields that are difficult to find
elsewhere in the world. So going in the other direction is not
an obvious choice.
"For most Latin American investors, it’s more
challenging today than ever before to find attractive
opportunities outside the region," says Maxi Rohm, who heads
Neuberger Berman in Latin America.
"Although pension funds and other professional investors
understand the need to diversify their portfolios into other
regions and asset classes, it’s challenging to do
so when there are better opportunities in local markets."
The conundrum is evident in Chilean pensions. They have
slightly more than $62 billion equivalent invested
internationally. That is 38.5% of their total assets and around
half of what they are allowed to allocate out of the
They learned about global volatility the hard way in 2008.
All but the most conservative funds lost 40% to 50% of their
investments outside Chile that year. But the funds largely
joined the global bounce in 2009, and by 2010 had close to half
their assets offshore.
However, since then they have relied on decent yields in the
domestic market to make up for weaker returns internationally,
says Marlon Valle, research analyst at investment consultancy
Data from Chile’s pension regulator shows the
funds did not have a bad year in international markets in 2012.
The riskier, Type A, funds returned 7.7% in peso terms on those
holdings. But that did little to compensate for bigger losses
the previous year for all but the most risk-averse funds.
Yet, in spite of the volatility, spreading the risk is
important. Neuberger’s Rohm says LatAm funds look
at international investments for diversification more than
"For the most part, investors are not looking at
investment-grade fixed income abroad," he says. "However, they
need to continue to address home bias issues and thus grow
their offshore investment programs. Offshore investing,
especially in fixed income, is really driven more by
diversification than by relative value at this point.
"So, investors in the region are fine going abroad even when
local interest rates are more attractive, but they tend to
focus on fixed income asset classes that offer sufficiently
attractive yields, liquidity levels and issuer diversification
that can be at times harder to find within the region."
Regulators in other parts of Latin America are a long way
from allowing pension funds the freedom to invest
internationally that the Chileans have. But changes are
Mexico’s pension regulator is clear that the
20% offshore investment cap needs to be raised. The
country’s pension assets are not just growing
impressively – they are becoming an increasingly large
proportion of the domestic market.
"Savings are growing much faster than the Mexican financial
system," says Consar’s Ramírez. "If you
don’t open the 20% limit, what’s
going to happen? The pension funds will continue looking for
best alternatives in Mexico. But if they will continue only
investing domestically, that will pressure prices up and
returns down in the Mexican market. If you pressure prices up,
there’s a risk eventually of creating a
Allowing the funds to diversify beyond Mexico will also
reduce the country risk in their portfolios.
That’s important to do, despite the positive
forecasts for the country, says Ramírez.
Already Mexico’s pension funds have gotten the
swing of diversification, broadening their portfolios from
nearly 100% allocations to government bonds in 2000 to just
over half that today. But they are taking to the offshore
investment limits slowly. While some are close to the 20% cap,
on average across the system pension funds have invested just
Across LatAm, rapidly growing pension savings are providing
support to sovereign paper – and that brings down the
benchmark rates for corporate borrowing as well. The need for
diversification outweighs the need to channel local pension
savings into the domestic economy, says Ramírez.
"We want the money the Afores are managing to be used
domestically to help the Mexican economy and to be invested in
productive activities in the economy," says Ramírez.
"But at the end of the day what we want more is that this money
is better invested with better yields, in a safer way, and at
the end of the day that’s going to translate into
In Mexico, despite the regulator’s view that
the offshore investment cap must be loosened, change is not
imminent. That requires approval from Mexico’s
congress – so far, it has had more pressing reforms to
deal with. What is expected soon, though, is the announcement
of a handful of mandates for external asset managers.
Mexico allowed pension funds to use third party managers in
2011. Since then, Consar has been in discussions with the
Afores over the external asset management mandates. As of late
April, five agreements were close to being finalized.
"We’ve had more than a year of very tight and
not easy negotiations between the Afores that are interested in
using this instrument, between the Consar, and the foreign
asset managers," Ramírez says.
Among other stipulations, Consar calls for third party
managers to have at least 10 years experience in asset
management and, for investing the cash offshore, at least $50
billion assets already under management.
Ramírez says he expects other Afores could follow
with third party mandates, once the first examples hit the
That is an opportunity for local and international asset
managers, says Carmen Campollo of Campollo Consulting. "The
pension funds have been very good at posting their requests for
proposals, in terms of the size of the managers that they need
to have, their capital, and experience with strategies and
products that are going to allow them to compete to manage
Afore XXI-Banorte is one that is already looking at the
possibility. It would like to see the offshore investment
limited to 40% of the total portfolio.
"We think the optimal thing is for the limit of investment
in foreign assets to open up and how Afore XXI plans to prepare
for that is through mandates," says CIO Ignacio Saldaña.
"If we don’t know Asia, I don’t want
to [invest there] with my team. We want to allocate resources
to that market, but we want to do it via a professional
In the meantime, XXI-Banorte is targeting the better
returning international assets – preferring equity
over fixed income – to make the most of that
allocation. That is a theme for others.
Across the board, Mexican funds have over 13% of their
assets invested in international equities, and just 2.1% in
Chilean funds also target paper with higher yield when they
look globally. Close to three-quarters of the cash they have
invested outside Chile is in variable rate instruments. And
most of what they put into bonds goes into high yield and
emerging market funds.
The biggest geographical allocation is in the US –
Chilean funds put about a third of international investments
there. Roughly half go to emerging markets, with 15% in other
Latin American countries.
The paradox of investors from a high growth jurisdiction
wanting to diversify away from those yields is perhaps most
striking in Peru. The country had the highest growth rate in
South America last year.
But funds here have been particularly vocal in insisting on
the need for greater room to invest internationally. The
regulator has acquiesced, increasing the offshore investment
limit in April for the third time this year, by two percentage
points to 36%.
"Yields in Peru should be higher that outside, even over the
longer term, since we are a faster growing economy," says
SBS’s Schydlowsky. "In addition, we have so far
successfully avoided being sucked into the world
Yet it is crucial that pension funds take a long-term view,
"At a fundamental level, the issue is how to generate
healthy returns in the medium to long term. Policy holders can
see their fund go down over the course of a week or a month,
but what we really should be looking at is returns over 20 or
For international asset managers, the bid to invest offshore
offers increasingly many opportunities. Funds in Chile,
Colombia and Peru have around $100 billion in assets they could
invest internationally, if they chose to fill their regulatory
limits, says Strategic Insight’s Valle.
Not all funds use managers for offshore investing though.
Colombia’s Colfondos, for example, conducts its
own research in house. It invests in Latin America and other
emerging markets, as well as the US.
"We are a conservative pension fund, and we invest in
regions that we know well," says president Alcides Vargas. "We
avoid highly uncertain investments, and in general we follow a
policy of simplicity."?
Delivering the goods
With their high targets, falling domestic yields, and
virtual absence of international investments, Brazilian funds
are perhaps the most in need of fresh investment
The defined benefit system translates into ambitious targets
for managers. Until now, high local yields have allowed them to
hit that threshold. But that is changing, and the funds are
looking overseas for help.
"In the whole of the Brazilian industry, there is less than
$100 million invested abroad," says Previ’s Sanda.
"We think this is going to change. The interest rate in Brazil
has declined very fast."
Virtually all Brazil’s pension fund assets are
invested domestically, a result of onerous rules for investing
internationally as well as domestic yields that were until
recently very high. Falling returns locally are now forcing
pension funds to deal with the complicated rules for
To invest offshore, Brazilian pension managers must go
through an investment vehicle in which they have a stake of not
more than 25%. That means teaming up with competitors and to
agree on what they will buy.
Previ is already in discussions with other funds to set up
an offshore vehicle. It plans to contribute a modest $200
million initially. That will go to an asset manager to invest
"The mandate that we’re going to give to this
manager is to find very plain vanilla stocks, long only," Sanda
tells LatinFinance. "Without derivatives. Companies will need
to be good payers of dividends, and with names that are easy to
sell in Brazil, large caps. I think this is going to be the
first movement. That is very easy to do. Probably in a couple
of years we’ll be more aggressive, but the first
move will be very plain vanilla."
As a consistent, long-term buyer base, pension funds across
Latin America have provided solid support to their
governments’ debt. Heads of public credit across
the region point to pension funds as a crucial support when
they come to issue in the local market.
"Pension funds have 28% of total TES," says
Miguelángel Gómez, Colombia’s
sub-director of public credit. "Those are the largest holders
of our local market. That creates a lot of stability for the
product. They buy, they hold, they have long-term view."
Relaxing the rules around how much pension funds can invest
overseas may knock that support. But the funds are also being
given greater opportunities to pick up other paper that
supports their local economies.
As pension assets have grown in Mexico, funds have been
given greater freedom to invest. Since 2010 they have been
allowed to buy shares in IPOs and from 2011, commodities. Last
year, the riskier funds had their caps on structured products
like real estate investment trusts raised.
Peruvian funds will be able to take on alternative
investments from August – that includes hedge funds,
private equity, and, crucially, infrastructure.
"This broadens the investment possibilities," says Michel
Canta, deputy superintendent at the SBS. "We are opening the
range of instruments they can invest in, to better diversify
their portfolios both inside and outside the Peruvian
At the same time, the rapid growth of retirement savings
means that even if greater proportions of the funds are
invested away from national government debt, the absolute
numbers may not drop much. Given the scope still left for
pension funds to expand their reach in the region, their assets
are set to continue expanding.
"We see a trend that towards a larger penetration in the
lower income population," says Grupo Sura CIO Ignacio Calle.
The firm owns a growing number of pension funds across LatAm,
most recently buying part of Spanish bank BBVA’s
Horizonte fund in April. Calle points to plans in progress in
Colombia to improve financial inclusion as a sign that client
bases will continue to grow.
"In Colombia [in March], the government announced a program
to increase coverage of low income population, in order for
these people to have pension plan at the end of their working
"If we implement system with full coverage to the full labor
population, that would be a major advance."