The Global Surge in Latin America Pension Funds
by Moises Vidal, Director, Treasury Sales Manager, Latin America Financial Institutions, Bank of America Merrill Lynch, and Tom Avazian, Managing Director, Global Banking and Markets Product Executive, Bank of America Merrill Lynch
The Latin America pension fund sector has experienced dramatic development in recent decades. Forward thinking decisions by many governments across the region during the 1990s and 2000s led to the establishment of mandatory participation for employees in many countries. At the same time, modest population growth, high levels of urbanisation and positive demographic trends – unlike many countries, Latin America has a growing working age population – have prompted significant growth in pension assets.
Today, assets under management (AUM) in Latin America exceed $900bn, and are doubling in size every five to six years in Brazil, Mexico, Chile, Peru, and Colombia . However, the scale of the region’s pension market varies widely depending on population size and market maturity. Chile has the most mature market, having established a regulatory framework for private pension providers, including a robust regulator, over 20 years ago: today AUM total more than $167bn . In contrast, Peru had AUM of $37bn in 2013 (although they have grown five-fold in the previous decade) .
While pension fund markets and rules differ significantly across Latin America, countries in the region have one important similarity: pensions are based on contributions to individual accounts in pension funds that are invested in financial markets and are managed by private companies. The principle of individual accounts managed by private sector firms (rather than public sector provision) has been an important factor in the growth and development of the pension fund sector for a number of reasons.
Private pension fund management companies have been able to innovate in terms of the types of investments they offer their investors. Moreover, they have often been active in lobbying governments in their countries to review restrictions on how funds can be invested. Two decades ago many countries required funds to invest almost entirely in the domestic market (and frequently specified investment in domestic government securities, in effect providing a captive source of public sector funding).
However, over time many countries have loosened their limits on the level of investment permitted in international markets, although levels vary widely by country. Today, Brazil, not coincidently the country in the region where the public sector plays the largest role in pension provision, has one of the lowest limits (at 10%), with Colombia and Mexico at 20%, Peru at 42% and Chile at 80% ,. It is widely expected that over time countries in the region will continue to increase the level of assets that can be invested overseas.
Increased breadth requires more sophisticated services
As Latin American funds have increasingly diversified the types of assets and range of geographies that they invest in – the US, Europe and Japan have been the main recipients of investment, although there is strong emerging market investment by Chilean funds – their need for services associated with investment and operational efficiency has increased. Historically, the securities services industry in many Latin American countries has had limited choice in terms of the service providers they work with; as a result the quality of services has sometimes failed to match international standards.
However, as Latin American pension funds venture overseas, they have an opportunity to put in place best-in-class solutions for principally custody, liquidity management (including short-term investment), settlement and foreign exchange. Funds from the region often have limited experience of operating across different time zones, different types of securities or in different currencies. It is therefore critical that they receive support to ensure their needs are met.
Moreover, Latin American pension funds are expanding internationally at a challenging time. The historically low interest rate environment in many countries around the world, unprecedented policy action (such as quantitative easing) and increased regulations (such as Basel III and money market fund reform) mean that it is crucial for pension funds to operate efficiently. Additionally, they must have sound risk management and access to resources to enable them to achieve their objectives.