What Latin American pension funds are looking for

Secondaries firms and mid-market tech funds are among the beneficiaries of the region’s increasingly sophisticated pension systems.

This article appears as part of Private Equity International‘s December/January Emerging Markets special supplement.

$928 billion – that’s how much the pension funds of Latin America had in assets under management at the end of 2018, according to a report from research firms Cerulli Associates and Latin Asset Management. This is forecast to hit $1.4 trillion by 2023. And like their counterparts in Europe and North America, these AFPs, as they are known, have struggled for returns.

Peru’s interest rate is at 2.75 percent and Chile’s at 1.75 percent, after the latter was cut in October for the third time this year. The base rate in Colombia, which rounds off the list of the region’s most sophisticated pension programmes, remains just above 4 percent, but has come down more than three percentage points since the start of 2017.

“Some long-term rates in Chile are negative, a similar phenomenon as in Europe,” says Ricardo Morales Lazo, co-founder of Santiago-headquartered placement agent HMC Capital. “The fixed-income portfolio is probably 50-60 percent of their [AFPs’] portfolios and that part is not yielding anything – that’s why they have had to look for alternatives.”

Mega-brands come first

Several regulatory changes have been implemented to allow AFPs to invest in alternatives. In 2017, Chile let pensions invest up to 15 percent of their assets in one of eight alternative asset classes. It also allowed international firms seeking to raise capital to do so without using a local feeder fund. Colombian pension funds must still provide daily valuations in order to receive AFP money, but from March 2016 they no longer need to rely on one of two official consultants to do it for them.

With the barriers coming down, how are pension funds choosing to invest? According to Rodrigo Manzur, former head of alternative investments at Chile’s AFP Capital and AFP Cumprum and now an independent consultant, multi-platform mega-brands were the first beneficiaries. Groups such as KKR and Blackstone first came to the continent in search of capital in 2009 after traditional sources dried up. Liberalised regulations just led to the deepening of these relationships.

“When Latin American pension plans started to invest in alternatives, usually the person in charge of [overall] asset allocation or international investments was the one that selected the private equity funds,” Manzur says.

Today, increasingly sophisticated in-house investment teams, often built with the help of personnel or expertise from abroad, are allowing AFPs to evaluate a greater array of strategies.

Secondaries funds have been a clear winner of this broadening appetite. Ardian’s latest fund, ASF VIII, counts on the support of Chile’s AFP Habitat and Peru’s AFP Integra, among others. Integra, Peru’s largest AFP by AUM with around $18 billion as of the end of October 2018, has also invested with Lexington Partners and Coller Capital.

“Secondaries are perfect for the portfolio [of AFPs]: frequent cashflows, a less volatile performance and they allow them to deploy large amounts of money,” says a director of alternatives at another large Chilean pension fund, adding that ticket sizes tend to be between $50 million and $200 million.

The flattening of returns among the mega-funds has also led AFPs to look at smaller or more specialised buyout funds, says HMC Capital’s Morales. Among the names he cites as popular with pensions are mid-market tech-focused groups such as Thoma Bravo, Insight Partners and Index Ventures. He also believes it’s a matter of time before AFPs move into the venture capital space.

“They started out with [multi-strategy] platforms but as they get more sophisticated and need to differentiate from their competitors, they’ve started to look for alpha through more unique GPs,” he says.

There are still obstacles to growth. While Chile has separate allocations for private equity and private debt, most other countries don’t. If forced to fit the two strategies into one bucket, pensions tend to plump for the latter, in line with their priority of boosting fixed-income returns. There is also frustration that some of the best-performing PE firms don’t feel the need to court AFPs.

But with huge amounts of capital to deploy and regulators increasingly aware of the role alternatives can play, they may not be able to stay away for long.