As we detailed in a February 2018 blog post, Mexico's pension fund regulator, the National Commission for the Pension System, which is known by its Spanish initials CONSAR, has been working to give pension funds the flexibility to shift a portion of their assets into vehicles such as mutual funds. Previously, pension funds have been limited to exchange-traded funds (ETFs) and separately managed accounts (SMAs) for non-Mexican investments. CONSAR is also introducing a slew of other changes including the expansion of target date fund options, greater access to foreign funds, and will allow a greater allocation to offshore funds. For foreign asset managers—especially providers of US based ’40 Act funds—this change, which is slated for December of this year, may present a compelling opportunity.
What follows is an overview of the major changes initiated by CONSAR and what it means for asset managers.
Changes at the Regulator
The July 2018 election of President Andrés Manuel López Obrador, affectionately known as AMLO, are giving regulators more flexibility to make changes that have been contemplated for several years.
Known as administradoras de fondos para el retiro or AFOREs, Mexico's 10 pension funds are being recast from company structures (Siefores) to more fund-like institutions (Fiefores). The change, to be approved by Congress, will give pension fund managers greater flexibility to manage the underlying funds. The industry expects that AFOREs will not need to make this change until 2020.
According to Moody's Investment Service, as recently as December 2018, Mexican government bonds constituted more than half of AFOREs' portfolios. While their share of 51.4 percent was lower than in previous years, many industry participants felt that this dominance was still too pronounced in an industry that requires diversification to protect its beneficiaries.
Moving to 10 Target-Date Funds
Another upcoming change is related to the way pension fund assets are managed. Previously, assets were spread across five vehicles (Siefores), whose risk profile ranged from most conservative to riskiest. Workers would move from riskier to more conservative funds as they approached retirement, which is a similar model to those followed by the other privatized pension systems in Latin America.
Now, the AFOREs may each have 10 vehicles, which will be managed like target-date funds, also known as life-cycle funds in some jurisdictions, so that workers will remain in just one Fiefore for their entire career instead of switching funds as they age to adjust the risk profile of their pension investments.
For current and future SMA investments, this could represent a challenge for managers as their investments will need to be spread out.
Foreign Investment Limit to Rise
In addition to allowing the use of domestic mutual funds, CONSAR is also allowing AFOREs to shift part of their assets into foreign mutual funds, which could provide much-needed diversification to the Fiefores. The funds have to be based in one of 51 jurisdictions (including the US, Ireland, and Luxembourg), have at least $100 million in assets, a minimum of a two-year track record, and the manager must have a minimum of 10 years of fund experience. In addition, the asset management company must have at least $50 billion AUM, although an exemption to this requirement can be obtained for certain specialty funds.
Currently, foreign investment by AFOREs is limited to 20 percent of their assets, but Mexican officials say that the new regulation allows AFOREs to increase foreign investment to 100 percent of assets. The Central Bank will allow this increase to take place gradually and will need to approve the increases.
At the same time, with the move to target-date funds, there will be much higher equity limits for the AFOREs, increasing from 40 percent to 60 percent on the most aggressive fund.
The Impact of the Tax Treaty Between Mexico and the US
Shifting assets into foreign mutual funds is expected to be especially appealing to US fund managers targeting pension funds because of the US and Mexico double treaty taxation agreement. This means that dividends paid by US vehicles have a 0 percent tax withholding, which has been a stumbling block for US fund sales in the rest of Latin America as the withholding rate is 30 percent.
The tax treaty means that US mutual funds and European UCITS will be competing on a level playing field, and due to Mexico's proximity to the US, there is a strong affinity for American financial knowhow in Mexico. A third party, the Mexican fund association, Asociación Mexicana de Administradoras de Fondos para el Retiro (AMAFORE), has been given the job of ensuring that new funds comply with regulations. Global managers will need to submit an application for approval and maintain it.
Under the new rules, CONSAR has imposed a maximum total expense ratio, which may pose challenges for some asset managers. For equity funds, the limit is 65 bps and for fixed income funds it's 35 bps. Managers with higher expense ratios can still offer their funds, but they will have to refund the difference between the expense maximum and their expense ratio back to the pension funds.
Also, mutual funds will be allowed to have a portion of their assets in derivatives, but only for limited purposes. No fund-of-fund structures will be allowed, except for the purchase of money markets to manage cash.
The changes in the AFOREs move to target-date funds are scheduled to take place on December 13, 2019. Congress is scheduled to vote September 13 on the legislation enabling the transformation of AFOREs into more fund-like structures, among other initiatives,
In practical terms, although some foreign asset managers have already approached AMAFORE in hopes of getting registered, the inclusion of mutual funds in the AFOREs investment portfolios is not likely to happen until 2020, as a result of the changes into target-date funds. Nonetheless, it will be nothing short of a revolution in the Mexican pension fund market.
The article was written by BBH Vice President Toshihisa Watabe.