Prima AFP would like to see limits on international investments liftged to that it can fully exploit its emerging consumer theme, writes Gail Moss

Prima AFP, the Peruvian pension fund provider, is turning the growth of the middle classes not only in Latin America, but also in emerging markets worldwide, into a successful investment story."We believe that in the current environment, this is a more sustainable story than, say, base metals or industries that depend on world growth," says CIO Alejandro Perez-Reyes. "The middle class is starting to demand more goods and services, so companies that provide those should get good results without a big negative hit from what is happening worldwide."

The fund was set up six years ago by financial services giant Credicorp - the first Peruvian group to be listed in New York - which also includes the high street Banco de Credito, and Pacifico Seguros, one of the country's biggest insurance companies.

All Peruvians working in the formal economy must choose between the state DB pension system and a private DC scheme run by a handful of managers including Prima AFP. Whichever scheme they join, however, members must pay in 10% of salary per month, with no employer contributions. Prima provides schemes for both employees and the self-employed, currently administering $9.8bn for 1.15m members - just under one-third of the Peruvian DC market - with monthly inflows of just under $50m.

On stopping work at 65 - the state retirement age - scheme members may either choose to take a programmed retirement (the income from which is recalculated annually, according to actual investment returns) or buy a lifetime annuity, using their open-market option, which must either be in US dollars or inflation-linked soles.

Contributions into the Prima scheme are invested in one of three different funds, each with a different risk profile. Mandatory contributions must go into one fund only, but members can direct extra, voluntary contributions into either of thr other two if they wish.
Fund 1 is for people close to retirement: 90% is held in fixed income investments (the minimum required by law) with maturities limited to three years. The law says that members must be automatically switched into this fund when they reach 60 - although they can stay in, or move to, Fund 2 (but not Fund 3) on request.

The other two funds are aimed at people who are at least 10-15 years from retirement. Fund 2 is currently invested 55% in bonds with the balance in large cap equities, real estate and private equity. In Fund 3, the proportion in equities and alternatives is 80%, the maximum allowed by law.

As at 30 September 2011, 25.5% of total assets under management was in foreign securities - 14.9% for Fund 1, 27.5% for Fund 2, and 34.2% for Fund 3.

A limit of 50% has been set by Congress, and a lower, operational limit of 30% by the Central Bank. These are limits which Perez-Reyes would like to see lifted.

"We like the liquidity and flexibility of the foreign markets," he says. "Peru's pension providers are too big for the local stock exchange and it can take us 400 days, minimum, to liquidate our holdings [...] At present, we have to use a buy-and-hold strategy on the stocks we own, and when I see a stock I like, the limit means I often have to stay in cash."

Perez-Reyes believes the 30% limit is likely to be raised by the Peruvian Central Bank, at the rate of 2% a year.

"When the legal limit was previously raised to 30%, the Central Bank raised the operational limit over a period of two or three years," says Perez-Reyes. "I assume that they will do something similar this time around. But they don't want to do it too quickly because it could generate a strong demand for dollars in a short space of time."

Another of the problems for pension funds is that transactions must be approved in advance by the Banking Superintendency. Perez-Reyes would like to see a relaxation of this rule, such as that in Colombia, where approval need only be given after the deal goes through. He does see a shift towards principles-based regulation, where the Superintendency would monitor operations at fund level instead of at transactional level.
"It is something that has already been discussed with the Superintendency and we have all agreed on it, so we should move towards it," says Perez-Reyes.

Investment policy is decided by the fund's investment committee. Prima's portfolio managers are essentially stockpickers, although they do carry out some top-down analysis as well.

"Right now, we are monitoring allocation very closely," says Perez-Reyes. "We are much more value- and sector-driven than geography-driven."

The research team travel all over Latin America visiting companies and fund managers.
"We only make direct investments where we can do our homework," says Perez-Reyes. "The further we are away from Latin America, for instance in Asia, the more we use managers. And at present, we are going to Asia for the middle class growth story."

Prima also uses collective investments - chiefly mutual funds or ETFs - closer to home. The type of vehicle used often depends on the theme Prima is chasing.

"We look for a story - say, the growth of internal consumption - and then we decide on the best way to play it," says Perez-Reyes. "If we're in our comfort zone in Latin America, we'll have an analyst who can research a stock, and if they find value there, we'll go and buy it [.…] If we're chasing consumption in Brazil, say, we wouldn't necessarily use ETFs: that means you get a replica of the stock exchange, which includes Petrobras - and I don't want to play the oil price. So I'd look for a fund manager instead."

Prima AFP has avoided Europe for the past three years. "We are very much focused on emerging markets for now, because developed markets are still complicated," says Perez-Reyes. "But we do need to invest more abroad because of the illiquid markets in Peru."

However, while emerging markets are a focus, Prima does not invest on the basis of comparisons between regions. "We won't stop investing in Asia because Latin America may be getting better returns," says Perez-Reyes. "If we did stop, it would be because Asia was slowing down."

Like European pension funds, Prima is increasing its exposure to alternatives, although it has no hedge fund investments as yet.

"We're increasing alternatives, because there are more inefficiences in the private than in the public markets," says Perez Reyes. "And private equity gives us exposure to sectors such as retail and healthcare which we can't access via the public markets."
Private equity holdings include Maestro, the home improvement store owned by Ace Home Centers in the US; airport operator Talma; and Celima, the ceramic tile manufacturer.

"The fact we're stockpickers means when we like the story we feel we're getting a better return by investing direct," says Perez-Reyes. "We also like the smaller companies. If smaller companies need more capital to grow, they're not going to be able to get it all from borrowing during the slowdown. That may mean more smaller companies coming to market."

He also looks forward to more privatisation of state companies in Latin America: "The Peruvian government is starting to sell off part of the state corporations - for example, 20% of Petroperu. If that is successful, we could get another Petrobras."

Prima AFP's funds have no real benchmark but it does compare itself with the other pension funds in Peru. There is no legal obligation to achieve real returns (Peru's inflation is currently at 4.2%) but at present, all its three funds are doing so: returns for the 12 months to 18 November 2011 were 8% (Fund 1), 13% (Fund 2) and 18% (Fund 3). This is net of annual management fees of 1.75% (the most expensive of Prima AFP' s competitors charges 2.15%).