Both Santiago and São Paulo are making significant strides towards becoming Latin America's foremost asset management hub. The Chilean capital has extensive experience, while the Brazilian metropolis already boasts the sixth largest asset management industry in the world. However, both are seeing their progress stunted by regulatory and taxation issues.

São Paulo and Santiago may seem unlikely rivals for position of Latin America's investment management hub. After all, Brazil has a meaty $1000bn mutual fund management industry and a 190 million-strong population, whereas Chile has a respective $33bn and 17 million people. Moreover, São Paulo was the top ranking Latin American international finance centre in The Banker's 2012 survey on asset management centres. But strangely, while Brazil is just waking up to its enormous potential, Santiago’s fund managers have been honing their skills for years.

The Chileans are capitalising on their experience to market themselves as the Luxembourg of Latin America: safer, more open and more experienced than their main rival. Brazil, meanwhile, is witnessing a startlingly fast if not chaotic transition from a sleepy fixed-income market to one where dynamic and international-thinking boutiques are starting to set the pace across multiple asset classes.

As the two centres jostle to promote themselves to a wider audience, both are grappling with hostile taxation regimes. The Chilean congress is slowly unraveling a complex regime, while Brazil charges perennially unpredictable tax rates that are the bane of foreign investors.

All eyes on São Paulo

Many working in São Paulo's financial sector are confident that the country is just starting to stretch its muscles and show what it can do. “Global players are looking at Brazil now we are the sixth largest asset management industry in the world,” says Luiz Sorge, director at the São Paulo-based Brazilian Financial and Capital Markets Association (Anbima).

Paulo Oliveira, CEO at São Paulo-based Brazil Investments and Business, says: “We are moving from a secluded, emerging market with high interest rates to an open, developed market with low rates so the timing is perfect for capital markets.”

A steep fall in interest rates – down 5% in little more than a year – comes as the administration pushes infrastructure projects and looks to catalyse foreign cash in the real economy. Mr Oliveira estimates that Brazil needs $300bn a year in infrastructure spending to sustain 5% annual gross domestic product (GDP) growth. The government knows that it needs to woo the private sector if it is to get anything like this capital.

There are some regulatory measures that make Brazil’s fund industry attractive, too. The equivalent to the Securities and Exchange Commission has devised a strict and transparent regulatory regime with Anbima at the heart of self-regulation, says Mr Sorge. This deters fraud in the local market, making a Brazilian version of the Madoff scandal unlikely. Furthermore, Brazilian regulation applies to multi-asset funds that have many similar characteristics to hedge funds, he says.

In Brazil, funds publish daily net asset values with a delay. “Brazilian funds are, frankly, significantly ahead of their US counterparts in terms of compliance and reporting,” says Rob Ellison, partner at the São Paulo offices of law firm Shearman & Sterling, who helps Brazilian fund managers market themselves in the US.

But even Mr Sorge and Mr Oliveira admit that there is a long way to go before Brazil can be considered a truly global player. Most of the fund industry revolves around local managers managing local money with less than $50bn in overseas funds, says Mr Sorge.

In transition

The industry has been painfully conservative as Brazilian investors cling to the certainties of government bonds, but that is changing as rates fall, says Mr Oliveira. The sovereign reached investment grade in 2008 and yields are now at levels where corporate issuance is attractive. Brazil’s corporate bond market is already taking off with debenture issuance hitting a record of 39.3bn reais ($19.3bn) for the year to August 7, 2012, compared to 48.5bn reais in all of 2011. Today, some 10% of funds’ assets are allocated to equities, but in the next five years investors will increase risk exposure.

The Brazilian industry has contacts on the ground but no access to overseas investors and foreigners have access to the investor base but not operations on the ground

Rob Ellison

BTG Pactual Asset Management is betting on that diversification. The manager has had a spectacular run up in assets and now has 95bn reais, but so far less than 5bn reais of that is in equities, says João Scandiuzzi, partner and chief strategist in São Paulo. But change is in the air. “We’re in a transition right now. In the past, a typical mandate would be fixed income, say a Japanese fund looking for yield. But recently, we have seen a shift to equities.” With very mixed performance out of the Bovespa since 2007, “investors want alpha generation through in-depth research by people who really know Brazilian companies and their managers”, says Mr Scandiuzzi.

More equity funds will enable Brazil’s mittelstand – mid-sized, generally family owned, specialised companies – to tap the equity market, says Mr Ellison. That would help diversify the Bovespa away from commodities. It will also require more zip out of Bovespa's five-year-old small and mid-cap market exchange, Bovespa Mais.

Economies of scale

The huge potential of Brazil makes it attractive to an ever-widening range of fund managers. New arrivals include Pimco, best known for fixed-income management, which is opening its first Latin American office in Rio de Janeiro. Meanwhile, emerging market manager Templeton has recently launched a Brazilian multi-asset fund to invest across equity, fixed-income and foreign exchange markets.

Tie-ups between foreigners and locals, including those between Highbridge and Gávea, and Prudential and GAP Asset Management, are also increasingly common. “There is a synergy between foreign and local managers,” says Mr Ellison. “The Brazilian industry has contacts on the ground but no access to overseas investors and foreigners have access to the investor base but not operations on the ground. They are starting to see different ways to put these two together.”

Home-grown boutiques are flourishing, too, says Alberto Elias, head of asset servicing at BNY Mellon Financial Services in Rio de Janeiro. “Often, partners from large retail banks open boutiques when they believe they have a real differential to offer the market,” he says. Brazil has 550 boutiques, although Mr Elias says that together these independents have captured just 8% of the market.

Distribution has stifled product diversification in Brazil with the largest retail banks jealously guarding access to their clients and directing them to stodgy proprietary products. That is slowly improving and institutions such as Bradesco and Itaú are increasingly moving their wealthy clients to open architecture structures where a client can pick the cream of the independent asset managers, says Mr Elias.

Sticking points

These improvements may not be enough to ensure that Brazil can overcome the thicket of problems that are currently playing to Santiago's advantage. Foreign investors’ foremost complaint is the Brazilian government’s constant meddling with taxes. A financial tax, imposed on bond transactions and sometimes equities too, has fluctuated unpredictably. At the same time, it has been difficult for Brazilian funds to structure the right offshore vehicle and break into the North American market through placement agents, according to Mr Ellison.

The other festering sore is corporate governance. That may surprise in a market renowned for excellent standards in its Novo Mercado segment – which is exclusively reserved for companies that have voluntarily adopted corporate governance practices. But investors say that the government itself has ridden roughshod over minority shareholders in companies where it has a substantial stake, such as energy corporation Petrobras and mining company Vale.

Finally, the Brazilian economy has cooled rapidly. GDP growth came in at just 2.7% in 2011 and is predicted to scrape through at less than 2% in 2012. Much of the decline can be attributed to the global environment and the dizzying drop in hard commodities prices, such as iron ore, to which the Bovespa market is skewed. But there have been signs that consumers have over extended themselves with higher non-performing loan levels and a first-half retail slowdown.

Counting on experience 

In Santiago, Fernando Tisné, chairman of the Chilean investment association and Latin American debt currency investment director at Moneda Asset Management, is confident that the country can take a bigger slice of the fund pie. “[Chile has] $10bn under management, almost all domestically. We expect that in the next 10 years we will be up to $25bn and that $10bn will be sourced from foreign investors,” he says.

Chile has some key advantages over Brazil. It has long been a very open economy with no capital controls, and it has a well-educated workforce and one of the most sophisticated and deep capital markets in the region. Santiago also has a head start on São Paulo, with 30 years of a well-ordered pension fund history.

Currently, fund managers such as Compass Group and LarrainVial are cultivating Latin mandates from around the world. Mr Tisné’s own Moneda Asset Management has seen foreign assets jump. Five years ago it only had Chilean clients; today, 15% of the $4bn it runs is from non-Chilean investors.

Brazil is seen as a launching pad for many regional asset management businesses because of its sheer size, Mr Tisné concedes. But over time, the tie-up between the stock exchanges of Peru, Colombia and Chile should improve liquidity and depth, market characteristics which are currently serving as one of São Paulo’s chief attractions.

Fighting for position

Mr Tisné questions whether São Paulo is the best Latin headquarter. “Brazil has too many taxes and capital controls and it doesn’t have a history of being an open economy. I don’t see Brazil becoming a Latin ‘Luxembourg’ and hosting pan-Latin funds, which is what we are trying to do here in Santiago,” he says.

Turning itself into a centre for fund registrations and all the mandates that would bring is a mouth-watering proposition for the Chilean industry. First, it must tackle its own bureaucracy. In its Asset Management Insights research series earlier this year, consultancy firm PricewaterhouseCoopers highlighted a “highly fragmented and complex set of regulations, which is hindering Chile’s development as a financial services centre”.

Mr Tisné acknowledges that its taxes are Santiago’s Achilles heel, but a project is making its way through the country's congress to reduce these taxes, he says. The rapid emergence of São Paulo and the gravitation of a host of companies to Latin America’s largest economy should encourage the congress to take action soon.

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