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AmericasFebruary 3 2004

Asset managers’ Latin boom

Jonathan Wheatley reports on the phenomenal growth opportunities of the asset management industry in Latin America, with Brazil leading the pack.When Brazil introduced a temporary tax on financial transactions, the CPMF, in 1997, it was met with howls of protest. It was a regressive tax that would damage the competitiveness of Brazilian companies, critics said, and once introduced, it was unlikely to be withdrawn. The tax has indeed persisted and is much despised. But one industry has done well from it: asset management.
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“Nowhere else in Latin America comes close to having an asset management industry the size of Brazil’s,” says Alfredo Setubal, president of Anbid, the Brazilian investment banking association and a vice-president at Itaú, Brazil’s second-biggest private-sector bank. “There are various reasons,” he says. “First is the CPMF.” While the 0.38% tax must be paid on money moving into or out of investment funds, it is not charged on movements within funds. So it is significantly cheaper for investors to manage their money inside a fund than outside.

Speedy growth

This and other factors have led to assets under management increasing more than four-fold in Brazil during the past 10 years. However, while Brazil remains the dominant market in the region, others are growing at equally impressive rates.

Chile’s mutual fund industry has grown at 19% a year for the past five years, for example. Before then, growth was hampered by a series of banking sector crises but a period of stability and low interest rates, plus regulatory changes, have revived the industry. In Mexico, too, new regulations and new investment opportunities promise healthy growth.

Structural differences

There are significant structural differences between these three markets. Both Chile and Mexico have handed management of their obligatory pensions systems to the private sector. Chile did so in the early 1980s; Mexico started the process in the late 1990s and will complete it soon. The amount of pension fund assets under management in Mexico, at $38bn at the end of June 2003, is fast approaching the level in Chile (see table).

Brazil has not adopted this system, however, and has no plans to do so. But it is reforming its two state-run pensions systems, for workers in the private and public sectors. As workers begin to realise that the state system is unlikely to provide the income they want in retirement, many are taking out voluntary private plans. Assets in these funds grew by more than 50% in the year to September 2003.

Mexico and Chile have allowed or will soon allow mutual and pension funds to invest in offshore assets; Brazil does not. In both Chile and Mexico, mutual funds may invest up to 100% of their funds in overseas instruments. Chile recently raised the limit for offshore allocations by pension funds from 16% to 30%; in Mexico, guidelines are being prepared that could allow up to 20% of pension fund assets going offshore from this year.

Markets dry up

“The problem is that capital markets across Latin America are drying up,” says Thomas Ciampi, director of Latin Asset Management, a consultancy firm based in New York. “There’s been a lot of effort to have assets remain onshore to boost local markets and encourage new issues, but it hasn’t happened. The only outlet has been to allow assets to go offshore.” In Chile, pension fund allocations in offshore instruments grew from about $3bn to more than $7bn between January and September 2003.

In Brazil, where fund managers must invest only in the local market, demand for anything other than plain vanilla assets is already meeting barriers. With the central bank’s base rate starting the year at 16.5%, earning healthy returns is no real challenge. Almost all allocations in Brazil are linked to interest rates, the exchange rate, inflation, sovereign bonds and (very much in the minority) equities. However, as interest rates fall – the base rate has fallen from 26.5% since January 2003 – demand for bigger returns is growing.

This has prompted the emergence of independent hedge funds, which have also been stimulated by consolidation in the banking sector: a number of fund managers formerly employed inside banks have set up on their own hedge funds. In addition, many banks are reluctant to offer high-risk products under their own brand for fear of contagion if anything goes wrong, preferring to offer third-party funds on an “at-your-own-risk” basis.

However, Marcelo Rabbat, director of Risk Office, an investment consultancy in Săo Paulo, says hedge funds already face a shortage of assets. “This is a big worry. These are narrow markets, very illiquid,” he says. “Hedge funds have excellent managers but they are growing too quickly. They already have $1bn under management. Once they hit $3bn there will not be any assets left.”

Mr Rabbat warns that this exposes funds to the short-term outlook of many investors. “This is dangerous,” he says. “Hedge funds usually set up positions for 30 days but if someone decides to withdraw, they have to undo those positions very quickly. That can lead to big losses.”

Emanuel Pereira da Silva of GAP, a Rio de Janeiro asset manager, says the firm recently closed its multi-market fund, with $170m under management, “because with limited liquidity, you reach a point where you can’t grow any further”.

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Capital market erosion

The underlying problem, says Carlos Ramos of ARX, another Rio fund manager, is that, after more than a decade of high interest rates in Brazil, investors are happy to lend to the government, thereby contributing to the erosion of wider capital markets. “No other borrowers can compete,” he says. “The government has been selfish in that respect.”

Such problems will only be solved when interest rates fall, and companies and others start competing for investors by issuing equities and other kinds of assets, such as corporate and mortgage bonds, that are common in developed markets but almost unknown in Brazil.

Nelson Rocha Augusto, president of BBDTVM (BB), the asset management arm of government-controlled Banco do Brasil, says the government’s target of reducing the ratio of debt to GDP from about 57% today to about 40% by 2010 will be a prerequisite of bringing more assets and greater liquidity to the market. Meanwhile, BB’s own funds continue to attract investors. “We’ve been launching equity and multi-market funds, and growth has been very significant,” Mr Augusto says. He points out that BB, with more than $30bn under management, is bigger than the entire Mexican fund industry combined.

Robert John Van Dijk, head of asset management at Bradesco, Brazil’s biggest private-sector bank, says that the recent lengthening of the government’s debt profile and its reduced dependence on foreign capital in the past year have already begun to stimulate the fund management industry but adds that progress will be slow. “The lack of a broader asset base imposes no restriction on the performance of funds; on the contrary, interest rates are still high,” he says. “But it does limit diversification of risk. We are still too dependent on public sector debt.”

Short-term outlook

Market development is also hampered by investors’ traditionally short-term outlook. Even new pension products, for example, allow investors to withdraw capital at a day’s notice, often without penalty. But players are trying to stimulate longer-term savings. Caixa Econômica Federal (CEF), the government-controlled savings bank, is preparing to launch a fund to finance construction projects based on receivables in the form of rent, for example.

Wilson Risolia Rodrigues, head of asset management at CEF, says the fund will encourage long-term savings as a result of the long-term rent contracts on buildings financed by the fund. So far, the CVM, Brazil’s securities commission, limits receivables funds to minimum investments of 25,000 real ($8907) but CEF hopes to obtain permission to open the fund to small investors, with stakes as small as 100 real. “We believe in the evolution of this market,” says Mr Rodrigues. “It’s part of the virtuous circle of lower interests rates and a return to economic growth.”

Meanwhile, however, short-termism remains a problem across the region. Jaime de la Barra, of the Compass Group in Santiago, Chile, calculates that nearly 40% of assets under management in Chile are in money market instruments that are used mainly for short-term corporate cash management. About 7.5% are in equities and the remainder are in medium-term and long-term fixed income. However, he says: “A significant portion of individual long-term investments are through the mandatory pension funds. A lot of people do not have more than the 10% of their salaries that they are obliged to save. So the growth of the industry these days is basically based on people moving bank deposits to more sophisticated savings vehicles.”

In Mexico, too, most investors are there for the short term, according to Mr Ciampi. “There is no penalty for early withdrawal [from voluntary pension funds] so they are not stimulating long-term savings,” he says.

Good news for Mexico

One source of growth for Mexican pension fund managers from next year, however, will be new legislation that will allow them to manage corporate as well as individual funds. Mr Ciampi expects pension fund assets under management in Mexico to increase more than five-fold to $250bn by 2015.

Mexico’s new legislation will introduce more competition into the corporate pensions market but this is unlikely to result in the emergence of new management companies. On the contrary, Mr Ciampi expects the remaining few medium-sized independent managers in Mexico to be absorbed by the larger firms – as in the rest of the region, that means the big retail banks.

“Distribution channels are extremely important,” says Francisco Murillo of Banco Santander in Santiago. “The industry is dominated by the banks that own the distribution channels. It’s very difficult for an outsider to come in.”

Nevertheless, some new entrants are expected. Valentin Carril of Citigroup Asset Management in Santiago expects the number of players in Chile to rise soon from 15 to 18.

Making the business pay remains the big challenge, though. Falling interest rates and greater stability are forcing banks to look for more fee-based earnings rather than relying on government paper. The rise of Latin America’sstill-incipient asset management industry, helped by proactive regulation and even the occasional regressive tax, will become increasingly important both for savings rates in individual economies and for the banking sector across the region.

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