SANTIAGO - Some international managers that jumped full speed into the Chilean AFP market were forced to hit the brakes in July when the local regulator moved to limit the level of mutual fund fees the private pension fund managers can pass on to their affiliates.
Previously, all mutual fund fees were incorporated in the net asset value and as such were paid by affiliates. As of Aug. 1, however, AFPs holding mutual funds whose total expense ratios exceed limits established by the Superintendencia de Administradoras de Fondos de Pensiones must pay the difference out of pocket.
Because AFPs have plenty of mutual fund options that fall within the guidelines, they flatly reject paying fees out of pocket. As a result, most spent the month of July redeeming their non-conforming holdings or negotiating rebate deals with international managers. Some international fund managers said they were reluctant to extend rebates, given the relatively small investments of the AFPs and the low margins associated with doing business in Chile. One manager also pointed out the AFPs are not typical institutional investors that can assume some of the funds' operational costs, such as custody.
Complexity of guidelines
As of May 31, AFPs were investing $4.1 billion, or 11% of their overall assets, in international mutual funds. While there are some 800 offshore vehicles registered to accept investments from AFPs, roughly 250 funds belonging to 43 foreign managers actually have received assets.
While registering in Chile and selling to AFPs had been a fairly simple process to date, what shocked most international players was the sudden complexity of the guidelines - there are 140 separate total expense ratio limits based on fund characteristics and assets under management - and the very short notice, just one month, they received.
Fund characteristics include asset class; geographic zone (developed, emerging or global markets); region (North America, Europe and Asia Pacific); and type of fund (index, sector-specific, growth, etc.). In terms of asset size, TER ceilings are higher for funds with less than $100 million under management, but gradually decrease. For example, TER limits for global sector funds range from 1.78% for funds with less than $100 million, to 0.86% for funds with more than $1 billion. As for U.S. stock index funds, the range is 0.57% to 0.33%.
"The pace that the limits ... moved through the system caught just about everybody off guard," said Steve Phillips, the Miami-based head of international sales for the Americas at Pioneer Investments. Pioneer's Luxembourg-registered U.S. High Yield Corporate Bond Fund had $64.5 million in AFP assets as of May 31. He said the fund's TER is within the stipulated limit of 1.01% for funds with overall assets of $100 million to $500 million, and as a result has not suffered redemptions. Pioneer had $90 million in AFP assets at the end of May, according to official statistics.
Most fund executives interviewed said they found the policy of placing lower ceilings on larger funds discriminatory, because on one hand it harms funds that have grown by virtue of their successful performance, and it presupposes a direct relation between the size of a fund and its expenses, despite the fact that some components of the total expense ratio are expressed as a percentage and not in absolute terms, such as, for example, management fees.
AFP Superintendent Alejandro Ferreiro acknowledged the regulatory agency believes a mutual fund's cost should play a role in the decision-making process. The measure "will foster a sensitivity to price, so that managers are more concerned with making investment decisions based on protecting affiliate assets," he said.
U.S. complaint
The representative of a U.S. manager selling Luxembourg-registered funds to the AFPs said 12 of his funds approved for sale did not conform with the guidelines because they are very large. Requesting anonymity, he argued that because pension managers will have more leeway to buy smaller funds that have high expense ratios, in the end fund affiliates might not see the benefits, just the managers of smaller funds. Over time, it might encourage managers to offer newer funds with smaller asset levels, instead of lowering fees on their larger funds, he said.
The move by the SAFP was its contribution to a joint memorandum published by the banking, securities and pension fund regulator ringing in the "multifund" pension system, which will separate the assets managed by the AFPs into five subfunds of diverse risk profiles, from 100% fixed income to up to 80% equity. With the inauguration of the system, a new range of investment options increasingly will be used by the AFPs, including exchange-traded funds, structured notes, local mutual funds and commercial paper.
Market sources estimate that up to 40% of the funds registered with the Risk Classification Commission, which approves international funds for sale to the AFPs, could be over the new limits. In any case, what may be a big problem for some, might be an opportunity for others. One high-level executive at a local consulting firm said "managers that are well represented in Chile could capitalize on an eventual AFP investment-portfolio restructuring."
Meanwhile, among the AFPs, there has been less concern regarding the possible loss of some investment alternatives, considering that approximately 80% of the registered funds are not receiving assets and so plenty of products exist to diversify portfolios.
AFPs may continue to invest in any of the funds registered with the CCR. But investing in funds with over-the-limit TERs would result in a direct charge to the pension manager. Axel Christensen, investment manager at AFP Cuprum, said he considers the measure a restriction, not a prohibition.
"For some time, the total expense ratio has been an important element in selecting a fund, although not the only one," Mr. Christensen said. "Performance being equal, we have favored less expensive funds. I feel this criterion is shared by the entire industry, and in fact, the average total expense ratio of the system has been decreasing in recent years."
