Administrators in Chile continue to be leery of hedge fund investing

SANTIAGO - Regulators in Chile continue to balk at allowing privatized pension managers, known as AFPs, to invest directly in hedge funds, but acknowledge they would approve AFP allocations to structured products whose underlying investments employed hedge strategies.

So far, no such investment funds have been approved.

AFP portfolio managers say access to hedge funds would rein in risk on international allocations, which are overwhelmingly biased toward long-only equity mutual funds. The AFPs, which manage the Chilean public's obligatory social security savings as well as some voluntary contributions to 401(k)-type plans, were allocating US$4.5 billion of their $35.9 billion in assets to internationally domiciled mutual funds as of March 31.

"These instruments allow absolute returns and to go short on positions," said Juan Cristóbal Alcalde, head of international investments for AFP Provida, Chile's largest pension manager, with $11.2 billion in assets. "They give us a negative correlation with respect to the markets and a high degree of portfolio diversification."

But hedge funds have some hurdles to overcome before they end up in the portfolios of AFPs. Asset managers interviewed for this article acknowledged that the conservative nature of the AFP business doesn't mesh well with the checkered past of hedge funds, and everyone is fearful of the consequences should there be another blowup like that involving Long Term Capital Management. Over the years, the AFPs have had to suffer through crises that left fund affiliates questioning the professionalism of management.

"It's still hard to forget the problems we had (in the mid-1990s) with developing-company closed-end investment funds," said Luis Díaz, assistant investment manager for AFP Magíster. "We lost 50% of our capital and right now we have shares that are effectively worthless."

According to Ramón Rebolledo, head of the foreign investment unit at the AFP Superintendent, issues regarding liquidity, regulation and excessive breadth of investment policies are behind restrictions from direct allocations in offshore hedge funds. "In any case, we are watching what is happening in this area in developed countries and are especially interested in (the) SEC hearings" that took place in Washington in early May.

The regulator added that at the moment, AFPs can gain access to hedge funds only if Chile's Risk Classification Commission authorizes a closed-end structured product whose underlying assets are hedge funds. The CCR is an AFP-financed entity responsible for deciding which vehicles are eligible to receive investment from AFPs. One of the CCR's big problems with hedge funds has been their inability to offer daily liquidity or even to know the funds' value on a day-to-day basis. Given the AFPs' historical emphasis on local short-term fixed-income products, regulations are not friendly to illiquid vehicles.

Cristian Ross, executive secretary of the CCR, indicated that no structured products featuring hedge funds have yet been approved. "Hedge funds have problems of volatility, lack of regulation, and little liquidity. They do not trade on an exchange and in general offer only monthly liquidity.

Nevertheless, these problems could potentially be resolved, mainly by giving daily valuation to the instrument," Mr. Ross said.