Latin America
06 February 2013
As investors are sold on Latin America’s solid economies, custodians
are following closely in their wake. AST takes a look
Image: Shutterstock
Latin America has moved on from previous political and economic crises to development and prosperity, with the shift from export-driven to consumer-based economies leading to a boom.
A region with many cultures and economies, it is a large emerging market that offers businesses in various industries significant growth opportunities. Multinational companies are thriving, despite economic rewards and growth that is sometimes hindered by political uncertainty.
Keith Mahon, managing director of Apex Fund Services in Uruguay, explains that Latin America is a very different today to what it was 10 years ago.
“The fiscal situation for many governments in these economies is excellent when compared to developed nations,” says Mahon. “The government debt-to-GDP is well below 50 percent in most countries. This lends itself to the ability to build infrastructure to further support the growing economies. There is a need for infrastructure improvements and population growth is driving this need for increased and better infrastructure.”
“Many of these markets are expected to see working population growth over the coming decades. A large young workforce means increased participation in the economy, while companies and governments benefit from low pension and medical expenses.”
Alejandro Berney, head of securities and fund services in Latin America at Citi, says that growth in the size of local institutional investors has been the biggest change in the last decade.
“Two decades ago, foreign investors dominated the local capital markets. But the local pension funds in Brazil, Chile, Peru, Colombia and Mexico are significantly large now, which has been a result of greater savings rates from a larger middle class boosted by a very positive macro-economic environment, and helped by the right demographics. Nearly two decades ago when this type of obligatory savings was set up, and thanks to the demographics, the pain from moving from a pay as you go system to a prefunded market-oriented system was small and did not incur in large.”
This, he says, has also led to the growth of the mutual fund market (through increased allocations of pension funds and individuals) and the insurance market, since the models that are used in these countries require the obligatory use of life insurance companies.
“The increased amount of assets has led to an increased sophistication of the local managers. The gap between a hedge fund manager in Brazil or in Manhattan has closed extensively to allow them to be as knowledgeable.”
As well as increased sophistication, the falling cost of technology has allowed Latin American managers to set up efficient trading platforms, with outsourcing allowing managers to focus their resources in trading.
Outsourcing of fund administration is a common market practice, particularly Brazil, with Chile and Colombia coming round to the idea, says Berney.
“Outsourcing of fund administration is market practice in Brazil. There are currently discussions in Chile and Colombia which could make it practice as well. In addition, in those countries in which you cannot distribute offshore products (Brazil) or when they are tax disadvantaged (Mexico), it is then common for a foreign manager to set up a local feeder fund. In those cases, they outsource both the custody and the fund administration. Once again, the ability to assist a client with both their local and global needs has been a plus for Citi.”
“One key important difference that we have seen in the requests for outsourcing is that unlike the developed markets where a drop of assets is requiring managers to outsource as a cost reduction strategy, the rationale for outsourcing in Latin America has been to be able to cope with increased volumes and increased complexity. Therefore, the economic dynamics are quite different, making it a larger margin market even if volumes are relatively lower.”
“In this post-Madoff era of the financial crisis, investors are driving the want for transparency and the need for independent third-party service providers for security and peace of mind,” says Mahon, adding that this has led Apex into not only providing fund administration services, but assisting managers with their middle and front office needs too.
Global asset managers outsourcing their custody arrangements are less typical, with Brazil being the exception that proves the rule, says Berney.
“The reality is that Latin America has a significantly large proportion (close to 75 percent) of trade and investment flows coming from North America and Europe, than within the region. Countries are relatively lowly integrated, which is a fact not always understood by outsiders. The asset management industry certainly reflects this. With the exception of a handful of local managers, most of them are experts only in their home country. There are very few managers that invest regionally.”
But, he adds, the trend to invest outside of their markets is growing stronger by the day. “With the exception of Brazil, managers and owners typically don’t outsource custody. In all markets they are allowed to be a direct participant of the depository. In those cases that they do (Chile and Mexico), the rationale is more of a liquidity need (for mutual funds and insurance companies, not for pension funds), or because it is sold together with fund administration (which is the case in Brazil).”
“But with the growing need to invest outside of their home country, local managers are increasingly driven to a need for these services. Because it is their first time, they appreciate a local contact that can assist them with the nuances of the process of global investing.”
Spices and silk
Five hundred years ago, Asia and Latin America were vibrant trading partners, with Spanish galleons heavy with spices and Chinese silk regularly making trips across the Pacific Ocean. Today, the centuries-old link between the regions is intensifying, with trade growing at an annual average rate of 20 percent.
“The increasing trade is bringing the economies closer together, and that creates interest to invest in each other,” says Berney. But a very large portion of those flows don’t go directly, but rather through European managers and structures such as UCITS, he adds. “Some flows also go through US-based funds, but pension funds prefer the UCITS structures and that is the lion share of the investment flows.”
The flipside is similar, he says, with Asian investors preferring UCITS structures (either directly as in Hong Kong), or through local feeder structures (as in Malaysia, Japan and South Korea). “Asian investors are quite comfortable with the UCITS structure and have a clear preference for these. As [a] sub-custodian in the region, and thanks to the fact that most countries are beneficial owner markets, Citi sees and closely monitors these flows into Latin America. What we have seen is a large increase in foreign direct investment. The relative contribution of Asia has doubled from 3 percent in 2005 to 6 percent in 2010 according to the latest figures available. The increased flows in FDI have been assisted multiple times by our agency and trust solutions, where clients are in need of structures to minimise risk during the acquisition of these assets.”
Best In Show
Brazil is a clear front-runner in the funds industry, having the largest and most developed fund marketplace for all kinds of funds. It is the largest mutual funds industry in Latin America and is ranked sixth in the world with $923 billion in net assets, according to the US Investment Company Institute.
Since 2005, with the relaxation of exchange controls, Brazilians have been able to invest offshore, although with the high returns that are available domestically in the fixed income market, few migrated. Conversely, interest rates have dropped considerably since then and even more so of late, which is forcing investors to seek returns elsewhere, says Mahon.
“Since 2007, regulations changed permitting more free investment internationally, however few, managers took advantage thanks to home-grown prosperity and international woes, now the managers are beginning to look elsewhere to satisfy investor demand for alpha. Funds in Brazil are only starting to show interest in UCITS, however, Peru and Chile appear to have more interest and use for these products.”
“Brazil historically has had a closed market from an investment standpoint,” says Berney. “Initially investments outside were not allowed, and when that changed, high real interest rates locally discouraged that outflow. With the constant drop over the last five years, local investors are increasingly interested in offshore assets, and an increasing amount is looking towards that avenue. But from an overall percentage standpoint, that is still very small in the range of less than 1 percent of of total assets. Certainly, we believe that this will grow over time, but it won’t happen overnight. It is a trend that we at Citi keep a close look on since the potential in sheer size is quite significant.”
Rather than marking out a specific country as ‘one to watch’, both Berney and Mahon indicate that growth is coming from other areas.
“The one to watch is actually the MILA market—Mercados Integrados Latinoamericanos—the Andean regions’ integrated capital market trading platform that links the bourses or ‘bolsas’ of Chile, Colombia and Peru,” says Mahon. “The integration of the bolsas has allowed for greater liquidity for investors while increasing opportunities and attracting foreign interest to the region. Mexico and Panama are also making steps toward greater integration with MILA as is the Brazilian BM&F Bovespa. Although we acknowledge that Brazil and Mexico are the developing superpowers, countries like Chile particularly have a sophisticated pension fund market and an advanced retail fund market, with a number of these focusing specifically on Latin America providing local knowledge and expertise on investment within the region.”
“There can be no doubt that Brazil has the most developed funds industry, in all aspects: sophistication (derivatives are very common), size (over $1 trillion in total assets) and complexity (all strategies are followed, from plain equities and fixed income to hedge funds and private equity),” agrees Berney.
“To highlight one country, it would probably be Colombia since it is discussing a new regulation for funds dividing clear roles and responsibilities between the asset managers and custodians. This can help it grow very quickly if it goes through.”
Berney points to an asset class that is growing quickly across all countries—the move to private equity-like investments—as an interesting new strategy. “The regulators in every country are keen on seeing these savings pools support the GDP growth, and therefore are allowing pension funds to invest in private equity—typically in the range of 5 percent of total assets. Mexico, Colombia, Argentina and Chile have started allowing this, and we have seen increased demand from both local and global managers in tapping these markets. In order to invest in private equity, funds need to invest in local structures (sometimes fiduciary in nature like in Mexico and Colombia, other times with local fund structures such as Chile, Argentina, Brazil and Peru).”
“Interesting enough, Brazil is going through the same process of increasing exposure towards private equity, but for a different reason. The falling interest rate trend that has been going on for the last decade has made pension funds look towards investments with greater returns, and private equity funds are a key part of that focus”
If the Latin American fund sector continues to expand in-line with the growth of the region’s economies, investors will seek out high-quality fund managers to provide them with access to the region and to enable them to take advantage of the trade free zones for foreign direct investment.
Opportunities in Latin America go beyond Brazil and Mexico—with Chile’s sophisticated pension fund market, Mexico’s retail pension fund market and Colombia’s new regulation all creating interest, as well as new non-country focussed developments such as the trading platform of MILA, and growth in private equity.
And as western European economies fight their way out of recession, and more of Latin America’s investments are redirected overseas, the lure of the region for global custodians players is an easy sell.
A region with many cultures and economies, it is a large emerging market that offers businesses in various industries significant growth opportunities. Multinational companies are thriving, despite economic rewards and growth that is sometimes hindered by political uncertainty.
Keith Mahon, managing director of Apex Fund Services in Uruguay, explains that Latin America is a very different today to what it was 10 years ago.
“The fiscal situation for many governments in these economies is excellent when compared to developed nations,” says Mahon. “The government debt-to-GDP is well below 50 percent in most countries. This lends itself to the ability to build infrastructure to further support the growing economies. There is a need for infrastructure improvements and population growth is driving this need for increased and better infrastructure.”
“Many of these markets are expected to see working population growth over the coming decades. A large young workforce means increased participation in the economy, while companies and governments benefit from low pension and medical expenses.”
Alejandro Berney, head of securities and fund services in Latin America at Citi, says that growth in the size of local institutional investors has been the biggest change in the last decade.
“Two decades ago, foreign investors dominated the local capital markets. But the local pension funds in Brazil, Chile, Peru, Colombia and Mexico are significantly large now, which has been a result of greater savings rates from a larger middle class boosted by a very positive macro-economic environment, and helped by the right demographics. Nearly two decades ago when this type of obligatory savings was set up, and thanks to the demographics, the pain from moving from a pay as you go system to a prefunded market-oriented system was small and did not incur in large.”
This, he says, has also led to the growth of the mutual fund market (through increased allocations of pension funds and individuals) and the insurance market, since the models that are used in these countries require the obligatory use of life insurance companies.
“The increased amount of assets has led to an increased sophistication of the local managers. The gap between a hedge fund manager in Brazil or in Manhattan has closed extensively to allow them to be as knowledgeable.”
As well as increased sophistication, the falling cost of technology has allowed Latin American managers to set up efficient trading platforms, with outsourcing allowing managers to focus their resources in trading.
Outsourcing of fund administration is a common market practice, particularly Brazil, with Chile and Colombia coming round to the idea, says Berney.
“Outsourcing of fund administration is market practice in Brazil. There are currently discussions in Chile and Colombia which could make it practice as well. In addition, in those countries in which you cannot distribute offshore products (Brazil) or when they are tax disadvantaged (Mexico), it is then common for a foreign manager to set up a local feeder fund. In those cases, they outsource both the custody and the fund administration. Once again, the ability to assist a client with both their local and global needs has been a plus for Citi.”
“One key important difference that we have seen in the requests for outsourcing is that unlike the developed markets where a drop of assets is requiring managers to outsource as a cost reduction strategy, the rationale for outsourcing in Latin America has been to be able to cope with increased volumes and increased complexity. Therefore, the economic dynamics are quite different, making it a larger margin market even if volumes are relatively lower.”
“In this post-Madoff era of the financial crisis, investors are driving the want for transparency and the need for independent third-party service providers for security and peace of mind,” says Mahon, adding that this has led Apex into not only providing fund administration services, but assisting managers with their middle and front office needs too.
Global asset managers outsourcing their custody arrangements are less typical, with Brazil being the exception that proves the rule, says Berney.
“The reality is that Latin America has a significantly large proportion (close to 75 percent) of trade and investment flows coming from North America and Europe, than within the region. Countries are relatively lowly integrated, which is a fact not always understood by outsiders. The asset management industry certainly reflects this. With the exception of a handful of local managers, most of them are experts only in their home country. There are very few managers that invest regionally.”
But, he adds, the trend to invest outside of their markets is growing stronger by the day. “With the exception of Brazil, managers and owners typically don’t outsource custody. In all markets they are allowed to be a direct participant of the depository. In those cases that they do (Chile and Mexico), the rationale is more of a liquidity need (for mutual funds and insurance companies, not for pension funds), or because it is sold together with fund administration (which is the case in Brazil).”
“But with the growing need to invest outside of their home country, local managers are increasingly driven to a need for these services. Because it is their first time, they appreciate a local contact that can assist them with the nuances of the process of global investing.”
Spices and silk
Five hundred years ago, Asia and Latin America were vibrant trading partners, with Spanish galleons heavy with spices and Chinese silk regularly making trips across the Pacific Ocean. Today, the centuries-old link between the regions is intensifying, with trade growing at an annual average rate of 20 percent.
“The increasing trade is bringing the economies closer together, and that creates interest to invest in each other,” says Berney. But a very large portion of those flows don’t go directly, but rather through European managers and structures such as UCITS, he adds. “Some flows also go through US-based funds, but pension funds prefer the UCITS structures and that is the lion share of the investment flows.”
The flipside is similar, he says, with Asian investors preferring UCITS structures (either directly as in Hong Kong), or through local feeder structures (as in Malaysia, Japan and South Korea). “Asian investors are quite comfortable with the UCITS structure and have a clear preference for these. As [a] sub-custodian in the region, and thanks to the fact that most countries are beneficial owner markets, Citi sees and closely monitors these flows into Latin America. What we have seen is a large increase in foreign direct investment. The relative contribution of Asia has doubled from 3 percent in 2005 to 6 percent in 2010 according to the latest figures available. The increased flows in FDI have been assisted multiple times by our agency and trust solutions, where clients are in need of structures to minimise risk during the acquisition of these assets.”
Best In Show
Brazil is a clear front-runner in the funds industry, having the largest and most developed fund marketplace for all kinds of funds. It is the largest mutual funds industry in Latin America and is ranked sixth in the world with $923 billion in net assets, according to the US Investment Company Institute.
Since 2005, with the relaxation of exchange controls, Brazilians have been able to invest offshore, although with the high returns that are available domestically in the fixed income market, few migrated. Conversely, interest rates have dropped considerably since then and even more so of late, which is forcing investors to seek returns elsewhere, says Mahon.
“Since 2007, regulations changed permitting more free investment internationally, however few, managers took advantage thanks to home-grown prosperity and international woes, now the managers are beginning to look elsewhere to satisfy investor demand for alpha. Funds in Brazil are only starting to show interest in UCITS, however, Peru and Chile appear to have more interest and use for these products.”
“Brazil historically has had a closed market from an investment standpoint,” says Berney. “Initially investments outside were not allowed, and when that changed, high real interest rates locally discouraged that outflow. With the constant drop over the last five years, local investors are increasingly interested in offshore assets, and an increasing amount is looking towards that avenue. But from an overall percentage standpoint, that is still very small in the range of less than 1 percent of of total assets. Certainly, we believe that this will grow over time, but it won’t happen overnight. It is a trend that we at Citi keep a close look on since the potential in sheer size is quite significant.”
Rather than marking out a specific country as ‘one to watch’, both Berney and Mahon indicate that growth is coming from other areas.
“The one to watch is actually the MILA market—Mercados Integrados Latinoamericanos—the Andean regions’ integrated capital market trading platform that links the bourses or ‘bolsas’ of Chile, Colombia and Peru,” says Mahon. “The integration of the bolsas has allowed for greater liquidity for investors while increasing opportunities and attracting foreign interest to the region. Mexico and Panama are also making steps toward greater integration with MILA as is the Brazilian BM&F Bovespa. Although we acknowledge that Brazil and Mexico are the developing superpowers, countries like Chile particularly have a sophisticated pension fund market and an advanced retail fund market, with a number of these focusing specifically on Latin America providing local knowledge and expertise on investment within the region.”
“There can be no doubt that Brazil has the most developed funds industry, in all aspects: sophistication (derivatives are very common), size (over $1 trillion in total assets) and complexity (all strategies are followed, from plain equities and fixed income to hedge funds and private equity),” agrees Berney.
“To highlight one country, it would probably be Colombia since it is discussing a new regulation for funds dividing clear roles and responsibilities between the asset managers and custodians. This can help it grow very quickly if it goes through.”
Berney points to an asset class that is growing quickly across all countries—the move to private equity-like investments—as an interesting new strategy. “The regulators in every country are keen on seeing these savings pools support the GDP growth, and therefore are allowing pension funds to invest in private equity—typically in the range of 5 percent of total assets. Mexico, Colombia, Argentina and Chile have started allowing this, and we have seen increased demand from both local and global managers in tapping these markets. In order to invest in private equity, funds need to invest in local structures (sometimes fiduciary in nature like in Mexico and Colombia, other times with local fund structures such as Chile, Argentina, Brazil and Peru).”
“Interesting enough, Brazil is going through the same process of increasing exposure towards private equity, but for a different reason. The falling interest rate trend that has been going on for the last decade has made pension funds look towards investments with greater returns, and private equity funds are a key part of that focus”
If the Latin American fund sector continues to expand in-line with the growth of the region’s economies, investors will seek out high-quality fund managers to provide them with access to the region and to enable them to take advantage of the trade free zones for foreign direct investment.
Opportunities in Latin America go beyond Brazil and Mexico—with Chile’s sophisticated pension fund market, Mexico’s retail pension fund market and Colombia’s new regulation all creating interest, as well as new non-country focussed developments such as the trading platform of MILA, and growth in private equity.
And as western European economies fight their way out of recession, and more of Latin America’s investments are redirected overseas, the lure of the region for global custodians players is an easy sell.
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