Chile is a pioneer in the pension world, not only in Latin America but on a global stage.
During one of the continent’s most notorious military dictatorships, a major shake-up of the Chilean pension system was carried out and its impact has reverberated around the globe ever since.
More than 30 years after the 1980 pension reform, many countries have since adopted its fully funded system. From its introverted beginnings, Chile’s pension funds are now firmly turned towards global markets. There is just one catch: Everything they invest in outside of Chile must be sanctioned by a risk commission. For the country’s second biggest investor, Cristian Rodriguez, CEO of the $40 billion private pension fund AFP Habitat, this means a lot of red tape.
However, the mutual fund industry allows him to side-step some of these stringent restrictions while remaining compliant.
‘The reason for using mutual funds corresponds more to the regulatory environment in Chile than to anything else,’ says Rodriguez.
Having spent 18 years with AFP Habitat, Rodriguez has been at the forefront of this international expansion, and has seen investment in foreign assets mushroom from zero to 40% of the pension fund’s assets.
‘Near the end of the 1990s our government began to allow pension funds to include more foreign investments and due to certain regulatory changes we tend to direct our international exposure through mainly equity mutual funds,’ he says.
Rodriguez joined the AFP Habitat group in 1994 and has worked his way to the top of its investment team over the past 18 years. He started off as a trader for four years and was later promoted to CIO. He spent 10 years in this role before being appointed CEO four years ago. Outside of work, he is a keen skier and sailor and likes to spend time with his wife and three children. He still finds time to squeeze in a good book and is currently reading Breakout Nations: In Pursuit of the Next Economic Miracles by Ruchir Sharma. Rodriguez hopes the author, who is also head of emerging markets at Morgan Stanley Investment Management, will give him some tips for finding the next diamond in the rough.
Operating under a watchful eye
All pension funds operate within a set framework but few have to deal with the rigorous regulation that characterises Chile’s pension system.
Watchful and thorough, Chile’s Risk Rating Commission will veto any markets and funds that do not fit its compliance measures.
‘The fund industry in Chile is highly regulated. What you can and can’t invest in is very limited and highly defined,’ says Rodriguez.
‘In the case of mutual funds, they each have to be approved by a commission.’
For example, says Rodriguez, Chilean pension funds can invest in the New York Stock Exchange and all equities listed there are available to them.
But there are a lot of stock markets, especially in emerging economies, that are out of bounds. ‘However, mutual funds that are invested in these prohibited stock markets are available to us and we tap them via this route,’ he says.
‘Emerging markets account for 60% of our international equity allocation thanks to this method of exposure.’
The global reach of the pension fund’s investments has been an ongoing project for more than 15 years and Rodriguez has played a key part having worked as its CIO for 10 years before being promoted to CEO in 2009.
‘When I first joined the company it only had investments in Chile, and now 40% of its investments are outside the country.
‘The group’s internationalisation was initiated at the start of the 1990s, shortly before I joined. At that time the government would only sanction investment in AAA-rated foreign government bonds, so it was a very small allowance, next to nothing.’
Of this 40%, three quarters is invested in equity funds with the remainder in fixed income funds. The bond allocation includes a large portion focused on high yield products and local currency emerging market debt.
Rodriguez prefers local currency to hard currency debt as he believes emerging markets’ growth will lead their currencies to rise more than the dollar. Implicitly, he says, it is a bet on their currency and not just their growth prospects.
Among the bond funds included in his top 10 are Fidelity’s US High Yield, run by Harley Lank, AXA’s US High Yield Bonds, managed by Carl Whitbeck and BlackRock’s US Dollar High Yield fund run by James Keenan, Derek Schoenhofen and Mitchell Garfin.
Initial fund selection is carried out by the Chile’s risk commission before Rodriguez and his team begin their analysis. The commission-approved list is regularly updated with the latest names of authorised mutual funds.
This provides the starting point for Rodriguez and his selection team. If they find an interesting fund which is not on the list, they must contact the commission but more often than not it will give it a green light.
‘The commission rarely excludes a fund but if we do invest in one that is not authorised we get an immediate fine from the market regulator.’
Rodriguez says they employ a consistent and structured approach to building their portfolio. ‘We focus on long-term analysis of these funds and look for managers who have been running them for a minimum of three years.
These are decisions and investments that we do not expect to have to change in the short term.
‘The manager’s style and character without a doubt plays a part and returns are also very important.’
Using his search for quality value managers to illustrate his point, Rodriguez says measuring a manager’s results and portfolio execution are important to validate its ‘value’ label.
AFP Habitat’s Top 10 asset management firms by invested assets
|Franklin Templeton||1.420 billion|
|BNP Paribas||435.5 million|
|Julius Baer||432.7 million|
‘If they achieve good returns during a specific period due to a certain amount of their investments being growth stocks then that is of no use to me.
Consistent style is key, he says, and he is not overly concerned when the manager is below the top performers if the reason is because he’s sticking to his strategy.
‘The growth and value story is a case I clearly remember around the end of the 90s in the Nasdaq bubble. We continued to hold a few value managers and saw that they were experiencing poor relative performance. But this was because they were committed to value stocks and didn’t add growth companies to boost performance.
‘Another example is a few years ago a lot of the emerging Europe funds had investments in the Middle East.
‘I can understand why some would have a small percentage allocated towards these countries but the truth was that a big part of their performance came from this region rather than a good selection in emerging Europe.’
Managers on the radar
Despite being a keen emerging markets investor, Rodriguez says his allocation to this asset class is fairly close to benchmark levels.
‘When it comes to the rest of the world we look at it as any international group would,’ he says.
For Latin America, his biggest investments are in Brazil followed by Mexico. In emerging Europe Russia comes top, while in Asia he holds China, India and Taiwan as well as frontier markets such as Thailand and Vietnam.
‘Due to our experience in Chile and knowledge of the market we run our domestic investments directly but in the rest of the world we feel we can offer little added value.
‘But as an investor from the emerging markets we have a different perception of risk than an investor from a developed market,’ says Rodriguez.
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One of six private pension fund groups in Chile and the country’s second biggest by size with $40 billion in assets. Workers in Chile are obliged to pay 10% of their salary into one of these six funds and can pay an additional voluntary amount. Habitat is number one in Chile for the amount of additional savings its clients contribute.
Almost all the mutual funds included in his portfolios are managed by foreign managers and he also has a portion invested in ETFs for some of his developed market exposure. ‘In less developed markets, where we believe there is value to be found, we will use active managers from international groups.
‘For example, in US large caps we would use an ETF but in a market like Brazil we prefer to go for an active manager more than an index-driven strategy because it is a market that is dominated by two companies.
‘In this instance we think there is a lot of value to be found by opting for an active manager, it is the same in emerging Asia.’
For the US he is currently invested in the Vanguard S&P 500 ETF as well as the iShares S&P 500 ETF.
Among the other ETFs he holds are two further Vanguard products, the Vanguard Total Stock Market Index fund and the Vanguard Emerging Markets Stock Index fund.
Good performance is one thing, but alarm bells ring for Rodriguez when a fund starts to behave very differently from the benchmark. ‘This prompts a call to the manager to find out why this is happening. We then decide whether we are going to continue with them.'
The next few years present another challenge for global investors, says Rodriguez, where diversification is no longer the key word.
‘We have to understand fully the way markets are working, the influence they have on each other, and why certain markets are more penalised while others are boosted due to asset allocation moves.
Chile’s pension system
In 1980 the country converted from a government-run scheme to one run entirely by private sector pension funds and was watched keenly for the impact this transition would have on the market. Many countries have since conducted similar reforms of their social security systems and Chile is considered a pioneer. Chilean pension funds are allowed to invest in an extensive list of instruments rated and approved by a Risk Rating Commission (CCR). In the case of fixed income instruments, they are required to have a rating between AAA and BBB or equivalent. Stocks have to be approved by the CCR, or meet some specific requirements with respect to results and assets.