In May, Chile's Administratoras de Fondos de Pensiones, which handle $24 billion of that country's privately managed pension assets, obtained approval to invest up to 37% of their assets in domestic stocks - up from the prior 30% cap.
At the same time, Chile's Superintendency of Pension Fund Administrators raised to 9% from 6% the AFPs' allowable foreign investments. And for the first time, half of the AFPs' allowable foreign allocation can be invested in stocks.
Other changes applicable to the AFPs included: permission to use derivatives - for hedging purposes only - and easing of some of the restrictions that apply to investments in project financing and venture capital.
(In another market-related change last month, Chile for the first time allowed equity mutual funds to invest up to 30% outside the country.)
Investment liberalizations were included in a capital markets reform law passed last year. But the law's implementation was delayed after a Chilean court declared it to be unconstitutional on technical grounds. This year, a higher court overturned that earlier ruling.
However, it was Chile's central bank that was empowered to lift the AFPs' limit on domestic stock holdings to 37% after the law passed. The law itself, Chilean sources said, retained the previously allowable 20% to 40% range AFPs could have in local stocks.
For the AFPs, the new investment rules will permit greater diversification and investment choice. These were sorely needed as their assets are rising rapidly. AFPs' assets have been "fueled in part by high stock market returns" and the rising number of participants in Chile's defined contribution pension system, according to a report by Salomon Brothers Inc., New York.
AFPs are the private companies that Chilean individuals choose to manage their pension assets in the defined contribution system.
The most pronounced effect of the new AFP rules: encouraging more investment in smaller Chilean companies. Until now, AFPs tended to invest heavily in larger-capitalized shares, especially those of electric utilities. That's partly because of complicated rules restricting how much AFPs can invest in each company. The exact limit is computed by a formula that takes into account each company's liquidity, ownership concentration and adjusted net asset value, explained Brian Pearl, equity analyst with Salomon Brothers.
The formula tended to favor liquid, bigger-cap stocks. But a recent change in the variables being computed gave a higher limit to most smaller-cap stocks.
"Therefore, it is likely that the AFPs' equity investment portfolios will ......change in the medium term as (their) weighting in electric utilities decreases in favor of other sectors," said a Salomon Brothers report in May. Companies that should especially benefit: Masisa, Copec SA, Andina and Cartones, Salomon's report said.
For their part, AFPs are delighted with the liberalization of the investment rules. "AFPs have been using all the limits they can on equities." So it's likely that "we will use the 37% limit on domestic stocks and in the future invest (up to the allowable) 4.5% in foreign stocks," said Santiago Edwards, chief investment officer of Provida Admnistratora de Fondos de Pensiones, Santiago.
News of the liberalizations briefly spurred buying in the Chilean market, which had been rebounding since March. Currently, Chile's market is the best-performer in Latin America. For this year through May 26, it was up 12.9% in U.S. dollar terms, according to the International Finance Corp.'s investible price index, compared with an 18.2% drop in the IFC's Latin America (investible) price index for the period.
Some analysts foresee additional market gains. "Although equity mutual funds may put some of their money out of the country, that will be more than counterbalanced by money coming in from pension funds," said James Walker, country manager, Barings Chile Ltd., Santiago.
However, some international investors are not ready to rush in. Investment restrictions for foreigners and high capital gains taxes deter some investors; in addition, the market is trading at an expensive price/earnings ratio of almost 21.
That reason is keeping the global emerging markets portfolios of State Street Global Advisors, Boston, out of Chile, according to Joshua Feuerman, vice president.
