Brazilian pension funds are expanding by 15%-20% per year and have already garnered assets of 400 billion reais, according to Raphael Santoro, a consultant at pension fund consultancy Towers Perrin in São Paulo. The big question is how fast larger pension funds will alter allocations, which are still very much geared to state and Federal debt.
If the picture on asset growth is generally good, the sophistication of funds varies enormously and some are too small to have very developed investment strategies. There are about 370 pension funds in Brazil although around 100 of them have assets under 100 million reais, says Fernando Lovisotto, a partner at consultancy Risk Office in São Paulo. Some four years ago, industry associations and lawyers were allowed to create their own funds, and more may well be launched. But start ups are constrained by a lack of sponsor money, says Lovisotto.
A particular concern for funds is fast declining interest rates. On September 5, the Central Bank trimmed the countrys benchmark rate again, cutting it by 25 basis points to 11.25%. Further reductions are likely. At the same time, regulations governing pension funds are being liberalized. Combined, the measures should exert further pressure to rotate from government debt to equity.
Previ Lights the Way
Smaller pension funds do not need to fear moving too quickly into equities for lack of peer support. A pioneer is Brasilía-based Previ, the pension fund for state-owned Banco do Brasil, the biggest in LatAm and 59th in the world in terms of assets, with roughly 110 billion reais. Previ has both the clout and confidence to invest in stocks and bucks trends seen in the rest of the industry, investing a full 64% in equities, according to José Reinaldo Magalhães, director of Previs investments. The results can be seen in a spectacular performance: Previ achieved a return of some 35% last year.
Ironically, the fund is cutting exposure to equity just as others buy more. Previ has special permission to exceed a 50% government limit on exposure to equities temporarily, but regulators have insisted the fund comply with the limit by 2012, according to Magalhães. To do this, Previ has already started selling, with some 5 billion reais trimmed from the portfolio so far this year. It also has roughly 30% in fixed-income, 3% in property and 3% in loans to employees. The long-term performance of the stock markets makes this an excellent time to sell down equities, points out Magalhães because of high valuations and the ability to lock in profits.
Still, Previ is exceptional. Most Brazilian funds are conservative: typically they invest just 16%-17% in equity on average, versus a government-imposed limit of 50%. Consultants are puzzled by just how slow funds have proved in buying stocks. We really thought that funds were going to be more aggressive, says Lovisotto. When real rates reach 5%, we will see a rush to equities, he predicts. Funds conservatism means that they have missed out on the last four years of sizzling performance and this may be reinforcing their reluctance to invest now: portfolio managers tell consultants they are afraid equity is overvalued, a forecast borne out by recent market turbulence.
Still, many are rewriting investment policies, according to José Luiz Fagundes, analyst at Arsenal Investimentos, which advises pension funds on allocations. Fagundes has met some 10 fund managers in the last few months who are actively looking for a larger allocation to equities and investments in new areas like corporate debt.
Funcef Eyes 30% Allocation
Funcef, the third largest pension fund in Brazil, agrees that pension funds are proving slow to adjust to the new reality. In the past, allocations were much greater than they are today, Guilherme Lacerda, its president tells Latin Finance. Funcef, mostly serving employees of giant state-owned bank Caixa Econômica Federal, is ahead of the pack. With assets of 27 billion reais and 84,000 participants, the bellwether investor already has a healthy 25% allocated to equities, up 7% in just four years.
Lacerda is pursuing a policy that will push exposure to 30% by the end of 2008, he says. The normalising of the Brazilian economy means that it will win share within global markets. Stock markets should continue to post a good performance. Although clearly there will be fluctuations, we expect there to be good growth on a two-to-four year basis, he predicts.
Certainly, pension funds are increasingly being scrutinised by the wider community of equity market investors. Equity analysts believe that they are starting to play a role in smoothing out volatility. Brazilian equity markets are heavily dependent on foreign money, with 60%-80% of the IPOs over the last two years being snapped up by foreigners, mostly from North America.
Regulations Start to Thaw
It is not just changes in interest rates but a gradual thawing of restrictive legislation that is encouraging funds to consider other assets. After intense discussions with representatives of the pension fund industry and national pension fund association Abrapp, the regulator, Conselho Monetário Nacional (CMN), passed a liberalising regulation, Number 3456.
The regulation makes two important changes, explains Santoro. Pension funds are now able to invest 20%, up from 10%, in credit funds. These typically include securitised assets, such as car loans and personal loans that are deducted from payroll. Pension funds can also now invest 3% in multi-market funds, which typically have aggressive performance targets, high allocations to equities and the ability to use long-short tactics as well as buy illiquid assets.
Previously onerous requirements for disclosure have also been loosened, giving funds more autonomy, Lovisotto points out. And the new laws allow defined benefit funds to exceed limits established by the CMN, if they are sufficiently liquid, says Santoro. The new regulations while not as far-reaching as some would like are a start, say consultants who reason that the CMN plans to make further, incremental changes.
Private Equity Push
Previ is determined to make the most of new opportunities and has already been blazing a trail in new areas like private equity (PE). We see this asset class growing substantially in Brazil and are investing in infrastructure and logistics because of the many opportunities in these sectors, says Magalhães. Previ emphasises track record in its process of picking third party PE managers, but also considers transparency and socio-environmental issues, notes Magalhães.
Previ has allocated 300 million reais to private equity so far this year. It is also considering investing in domestic hedge funds. These investors, often specialist boutiques, have been notching up impressive returns. Magalhães acknowledges that one of the deterrents is the possible addition of risk. We have a conservative attitude to risk here. And you have to remember that 60% of our assets are already in equities, he points out.
Funcef too is starting to invest in PE, according to Lacerda. The participation of private equity is very low in Brazil, compared to other countries. We are on the way to enjoying solid economic growth of about 5%. That will open up many more possibilities for investment, he says. Most of the PE funds in Brazil invest in infrastructure, energy, transport, logistics and basic sanitation. Funcef is also looking at earlier stage deals through venture capital funds, for example in technology and software development as well as in food industries, he notes. The fund will be co-operating with asset managers on the selection of companies. We had many problems with managers in the era of telecoms and infrastructure privatisations. Now, we want to keep a closer eye on them, he says.
Fixed Income Moves
As well as a large portion of pension funds fixed-income portfolios shifting to equities, there is likely to be a shift from government paper into corporate debt. At the end of 2006, funds were investing some 17% in corporate bonds and they are expected to increase this to 25% by the end of 2007, according to Santoro. Funcef, which has a lower allocation to fixed-income than many, at 65%, is almost exclusively invested in government debt, with 95%.
Previ has almost all of its fixed-income investment in government debt, with just 1.3% in corporate names. Much of that can be explained by a paucity of corporate issuance and lack of liquidity. But that is changing. Theres a good interaction between companies and pension funds. Companies are keen to issue debt and were keen to diversify and keep a good level of income, says Magalhães. That means Previ will be seeking to re-orient part of its fixed-income portfolio to corporates as the market matures. Others will likely follow