By early October, Chile’s Pension Superintendent is expected to publish a framework of general provisions that regulate private-pension-fund investment in alternative assets.
It is noteworthy that, almost without precedent, these regulations were submitted for two rounds of public comment, mostly by market actors. Many comments were received in the first period, several of which were incorporated into the text submitted for second consultation.
Apparently, the end result will be well-aligned with the expectations of market players, who in general consider that this is an important advance for the diversification of pension investment and availability of instruments that offer very competitive returns when compared to more liquid assets.
However, despite the many positive aspects, the new regulations are not expected to clear up uncertainty over the compensation of third-party managers that has cast a shadow over the the AFP industry. As noted, President Michelle Bachelet has issued a declaration of intent to force the AFP pension managers to pay a portion of third-party fees, as opposed to expensing them to the pension funds and affiliates.
“In such a scenario, alternative funds, which charge higher fees due to their special characteristics, would be the most impacted, because AFPs will prefer instruments with lower fees,” a source told Fund Pro Latin America.
According to the Pension Superintendent, the objectives of the new general provisions, which should come into force next November, are to expand diversification of investments, improve returns, allow long-term investments and invest directly in broader variety of assets with possible cost savings for pension and severance funds.
One of the key elements of the new regulation is that pension funds will be able to invest between 5% and 15% of their AUM (according to Central Bank criteria) in alternative assets, all bunched in a special category, without competing with other asset classes, which is considered essential for promoting alternatives over other more advantageous options in a short-term outlook.
Some players said they would have preferred the use of sublimits to differentiate between different types of alternative assets, as in Peru, but these comments were apparently disregarded by the authority for now.
The creation of the alternatives class with sublimits would have encouraged additional investment in real-estate and infrastructure assets which, although they offer lower returns, are less volatile and have lower associated risk, thus complementing the AFPs’ investment portfolios.
“Without this differentiation, when pension funds are limited in space they most likely will prefer private equity over alternatives,” according to Ignacio Montes of Credicorp Capital.
The regulations also allow pension funds to invest directly in foreign alternatives, with no need for a local vehicle (feeder fund) as has been the case until now. In any event, these funds must be registered with the Risk Rating Commission, obviously with different criteria from traditional funds.
According to Ricardo Morales of HMC Capital, the transition to the new system will not be quick, since direct investment is more complex in terms of due diligence and legal processing. “On the other hand, the fees paid to feeders are very low.”
On the alternative assets suitable for investment, the regulations consider the following: vehicles for investing in foreign private capital assets; vehicles for investing in foreign private debt; co-investment in private capital and private debt abroad; equity of national closely-held companies (this group includes shares in infrastructure concession and real-estate companies); non-housing endorsable mortgage loans, domestic non-housing real estate leasing; participation in syndicated loans and national non-housing real estate for rental; and public limited companies (SpA) and national partnerships limited by shares.
For the time being, hedge funds and commodities have definitely been left out of the assets that qualify for investment in alternatives, and will very likely also fall outside the general criteria for investment in the restricted category.