Mexico goes conservative route in private pension vote

MEXICO CITY — There'll be no Chilean-style asset-gathering fiesta for fund firms when Mexico's privatized pension managers, known as Administradoras de Fondos para el Retiro, or Afores, get their first crack at international markets in December.

Earlier this month, the board of governors of the Comisi%F3;n Nacional del Sistema del Ahorro para el Retiro, or Consar, which oversees the pension system, took its long-awaited vote to approve three decisive measures: to allow the funds that make up the $40 billion system to diversify portfolios outside Mexico; to permit for the first time allocations in equity-linked vehicles; and to split each pension manager's current one-size-fits-all investment fund into two separate funds with different risk-return criteria.

With the vote, the Consar's executives got the go-ahead to begin drawing up the specifics for the transformation of the system, which the agency predicts will take until year end.

Mexico's legislature voted in late 2002 to allow the Consar's board to consider international in the allocation mix. That vote came after the implosion of the Argentine system, which was heavily exposed to local government debt when the country defaulted on its obligations in late 2001.

As for equity investing, this possibility had been open to the board for some years, but board members representing union interests had been opposed to the idea given the high volatility of Mexico's stock market.

But despite the opening into new markets and asset classes, the Consar's initial approach was deemed conservative by industry observers: it allows domestic and international equity investment only in principal-protected notes that are, in turn, linked to a range of global indexes. On the bond side, only notes rated A- or better can be used.

Eduardo Silva, former head of the pension fund association Amafore and current director of Afore Profuturo GNP, noted the tack chosen by the Consar was appropriate given the obligatory nature of participant contributions. "This is a long-term system, and we have to maintain the prudence that has characterized the system since its launch, in order to avoid running unnecessary risks," he said.

The Consar said it succeeded in its immediate goals, which were to provide diversification to the pension funds, which invest overwhelmingly (82%) in local-government securities; give affiliates the chance to benefit from long-term investing in equities; and avoid an artificial lowering of local interest rates, which would negatively affect pensions through low returns. Mexicans pay a relatively low portion of their salary (6%) into their Afore, so maximizing the return on investment is crucial. With historically high interest rates in Mexico seemingly a thing of the past, the Consar believes the timing is right to include equities in the mix.

Mutual fund managers, who lobbied the Consar hard over the past year to get their funds included in the investment regimen, came away with little. The Consar said it would permit the Afores to hire global managers for a mandate, but that all expenses would have to be paid by the Afores, not the participants. This is a sharp difference from the Chilean model, in which mutual funds have been the instruments of choice, with fees passed through to participants.

Global fund firms have raised more than $10 billion in mutual fund assets from Chile's AFP pension managers.

Those interviewed said they were disappointed with the limited scope of Mexico's new investment regime. During the past year, executives from firms such as Fidelity Investments, Franklin Templeton and the Vanguard Group have visited Mexico to investigate their opportunities to sell into the Afore market.

One executive of a leading foreign manager in the Chilean market questioned the potential upside of the principal-protected notes, as limiting the risk of the instruments usually limits their return. "When you realize that most participants will not retire for 20 years or more, vehicles that are guaranteed not to lose over the next three or five years serves no real purpose," he said.

The Consar said the eschewing of mutual funds stems from its continued campaign to lower the fees paid by participants. Isaac Volin, the Consar's vice president of planning, said in an interview, that any underlying fees in principal-protected notes offered by third parties could not be passed on to affiliates. This would likely lead the Afores to purchase locally packaged structured notes from local brokers as opposed to fee-heavy capital-protected notes sold by U.S. managers to conservative retail investors.

But because expenses of hiring a third-party manager would have to be borne by the Afores, few believe they will dish out cash to pay outside advisers, especially for an investment-grade portfolio.

Nonetheless, the market buzz at a recent industry conference was that brokerage firms like Goldman, Sachs or Bear Stearns would be quick to snap up such business to gain institutional assets. Some asset management firms with links to investment banking operating locally in Mexico, like J.P. Morgan Fleming Asset Management and ABN AMRO Asset Management, are also considering possibilities, sources said.