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Securities and Fund Services

Citi OpenInvestorSM

Emerging Market Playoffs: Asia v Latin America A Cup Winner or a Close Second? Citi hosted a panel at FundForum International’s Global Growth Summit. The panel, which consisted of two Citi specialists and two local fund managers, compared the opportunities open to fund managers in Asia and Latin America. Here’s what Citi’s Securities and Fund Services Asia-Pacific Head David Russell and Latin America Head Alejandro Berney had to say alongside ChinaAMC’s MD Freddie Chan and BTG Pactual’s Executive Director Ricardo Kaufman. Asia: this young upstart is an underdog no longer David Russell Asia’s extraordinary economic growth story is one with which everyone is familiar. Never mind the statistics: you only have to compare a photograph of Shanghai in 1990 with one of Shanghai today to grasp the scale of what has happened. The city has been transformed in line with the Chinese economy in just two decades. Meanwhile, stock markets across Asia have grown in line with the macro numbers. In 1990, Asia ex-Japan accounted for just 5% of a world market capitalisation of USD8.8 trillion. In March 2013, the comparable figure was 24% of a USD57.4 trillion world market figure. The value of the region’s stock markets has grown by a factor of 34 over the period. The region’s propensity to save is exceptional. Gross national savings range from a low of 24% of GDP in the Philippines to a high of 50% in China. That compares with 13% in the US and 19% on average across Europe. There has been strong growth in both retail and institutional assets, although there are substantial variations in the size of the market between the different countries, China and Australia being the largest in both cases. The key to the future for the funds industry in Asia is pension reform. For some idea of the likely impact one only has to look at the growth in Australia’s fund management industry since 1992, when pension reform began to take effect there. In just over two decades, pension assets per capita have grown from around USD8,500 to over

USD68,000. GDP per capita has also skyrocketed. As a result, assets under management in Australia have grown from USD150 billion to USD1.55 trillion. Among the countries embarking on pension reform is Taiwan. Citi is currently advising the Taiwanese government in this area. Taiwan is expected to travel a similar route that Australia has with some of the changes coming in next year. There is a close comparison to be drawn between Australia back in 1992 and Taiwan today. Pension assets per head are just under USD4,000 in Taiwan (just under half of Australia’s starting level in 1992), but GDP per capita is slightly higher. Both the proportion and number of the population over 65 are similar to where Australia was then. What does this mean for the fund management industry? Assuming pension reforms are enacted and GDP per capital grows at consensus rates, Taiwan’s asset management industry could grow from USD92 billion today to over USD600 billion by 2025. That provides some measure of the opportunity on offer. Similar growth trajectories can be envisioned in a number of other Asian countries. But it is China that is the most interesting. Pension assets per capita today are just USD369 while GDP per capita is just over USD6,000. The proportion of the population over 65 is in line with Australia’s at 14%, or close on 200 million people. If you fast-forward to 2025,

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Domestic equity market capitalisation: 1990 to March 2013 APAC (exc. Japan) market capitalisation increased from USD404 billion (1990) to USD13.4 trillion (March 2013)

1990 world market cap = USD8.8 trillion

2013 world market cap = USD57.4 trillion

Asia ex Japan — 5%

Europe — 24%

Asia ex Japan — 24%

Europe — 23%

Japan — 33%

Other — 7%

Japan — 7%

Other — 11%

United States — 31%

United States — 35%

Source: World Federation of Exchanges, 2013.

with the one-child policy China had in place for so long, some 20% of the population will be aged 65 or more. China needs pension assets to be built up. Its asset management industry currently has around USD500 billion of assets. If you assume consensus GDP growth rates and factor in pension reform, it is highly likely that the asset management industry could grow to around USD15 trillion by 2025.

are the oldest in China — so that demonstrates how young the domestic industry is. Total assets under management within the public fund companies in China account for less than 15% of the domestic market capitalisation. This is far below the penetration levels of mutual fund companies in the US or Europe. The capital markets still have a long way to go — as do asset management companies.

That, in a nutshell, is the fund management growth story from Asia. The region is right at the start of the reform process that occurred in Australia in 1992, and we can expect a similar impact over the coming years. In sporting terms, this is a complete game-changer. If we are looking for a cup winner, I would suggest Asia is the obvious candidate.

People see China as a potentially huge retail market. There is a high savings ratio and investors do need to diversify their savings. But, over the last two or three years, mutual funds have seen net outflows. Wealth management products linked to financial activity in Chinese corporations have been launched by so-called trust companies and distributed by banks, and these usually offer a return of 7% or 8% (returns have been higher still). The regulators are taking measures to prevent this “shadow banking” activity getting bigger. It is not sustainable. But, in the meantime, if investors can get fixed returns of 8%, why would they bother taking the risk of investing in a mutual fund?

Freddie Chan It is important to remember there are big differences between markets in Asia and in Latin America. Each has its own traits and characteristics. To think in terms of emerging markets can be misleading when you have big, highly rated growth countries such as China and Brazil. We believe one should look at different countries and regions individually to establish what is attractive. It’s important we focus on China both as an asset class for global investors and as a market in which investment managers can distribute their products. ChinaAMC was set up in China 15 years ago. By global standards, it is a young fund management company. But we

Equally, past attempts to diversify into foreign markets have not been entirely successful. Chinese investors picked the wrong time, late 2007, to start investing overseas. The lesson they learned was clearly not a pleasant one, and that still colours their attitude to overseas markets. In addition,

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Pension industry reform – growth projection for China’s pension assets (at 8%)

Australia 2013 Total pension assets — USD1,555* % population aged over 65 — 14% (3.1 million people)

China 2013 Total pension assets — USD500

2034 Total pension assets — USD45,000 Population aged over 65 — 14% (200 million people)

% population aged over 65 — 9% (122 million people)

Sources: Cerulli Associates, Respective Funds Associations, IMF, Population Reference Bureau, The Conference Board, US Census Bureau International Database, SFS Calculations. Assets and % pop 65+ based on 2025 pops./country GDP per capita. Prospective figs. are not forecasts. Pension assets growth subject to factors incl. savings rates, regulation pace and market performance, not necessarily included in asset size calculation.

interest rates in China are relatively high, with a number of products delivering 6% annual returns. That said, in some respects attitudes are changing. People are more familiar with the idea of asset segregation and more conscious of the opportunities in other Asian countries. High-net-worth individuals are taking steps to diversify, and sooner or later retail investors are going to do the same. This will create opportunities for foreign investment managers going forward. At the same time, Chinese regulators are working to encourage more overseas products and services into the domestic market. One example: they are working with the Hong Kong securities regulator on a scheme that would allow Hong Kong funds to be mutually recognised. This is likely to take effect next year or the year after. As such, it will represent a major step towards opening up the domestic market to foreign managers and products. As far as investing in China is concerned, I have to admit that there has not been very much to excite in the past six months. There are several reasons for this: concern over economic slowdown, the issue of increasing debt and the efficiency of the local currency. As local managers, we feel that people tend to put too much focus on the macro GDP number. Even if China’s growth rate is slowing to 7%, it still leaves China one of the fastest-growing economies in the world. We particularly see huge opportunities from the rebalancing of the economy towards increased consumption — opportunities that may not show up if you focus only on the index benchmark. For example, while the domestic index has

been trading down by around 5% over the past couple of months, there was a 50% return difference between the best and the worst performing sectors. With the right investment choices, there is no need to worry about economic slowdown. Latin America: a class act with giant-killing qualities Alejandro Berney Latin America may not be able to compete with some of the numbers coming out of Asia. But savings rates are still some 50% above US levels, at an average of around 20% of GDP. Looking at the fund industry, Brazil continues to lead the way, with combined retail and institutional assets of USD1.5 trillion. In terms of mutual funds, Brazil is the eighthlargest market in the world, and it has been growing at more than 10% over the past five years. However, it is very difficult to navigate, with its own set of rules and regulations. In the world of pensions, Latin America is ahead of Asia, having started the reform process as early as the 1980s. Chile initiated reform with a mandatory pension fund model that was then copied across Latin America. That model has been working very well. High growth rates in pension assets are linked to an expanding middle class and a growing number of people who are participating in the formal, rather than informal, economy and who, as a result, are starting to contribute to pension funds. The most interesting opportunity in the short term is in the marketing of cross-border funds, in particular to the region’s pension funds. Brazilian pension funds have not yet started investing cross-border. Technically, the domestic pension funds can only invest in local mutual funds, which may then invest a certain proportion of their money internationally. By and large, Brazilian funds have kept to the simple policy of

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capturing high local interest rates. However, these have been coming down over time, and there is increasing talk about the use of cross-border vehicles. The leading institutional market for cross-border funds is Chile, where pension funds held around USD67 billion of crossborder funds at the last count. But there are strong growth rates in Mexico, Columbia and Peru. In the case of the last two countries, there has also been investment into ETFs. Around 90% of the mutual funds that are being purchased are UCITS. This is an attractive segment of the market, not least because the number of targets is small. There are only six pension funds in Chile, four in Peru and four in Columbia. There being no requirement to set up local vehicles in these markets means bureaucratic hurdles are kept to a minimum. With the ability to sell direct to institutional funds, international fund managers have a major growth opportunity across the region. So there you have it. To return to the original question — is Latin America the cup winner or just the runner-up? — well, perhaps Brazil’s record in the World Cup as a five-time winner tells you all you need to know . . . Asia may be a favourite for the trophy right now, but Latin America also has a winning formula. And it looks to me as if it is set to stay in the top bracket for many years to come. Ricardo Kaufman To update you, BTG today is the largest independent asset management group in Latin America, with a large regional funds distribution capability. A previous panel divided asset managers into two categories: global and boutique. They forgot a third category: regional experts. BTG falls under that category. We are not boutique because we manage in excess of USD90 billion of assets.

And we are definitely not global (nor do we want to be seen as such). No, we are Latin America and regional experts. Earlier, David Russell said you only had to compare pictures of Shanghai 20 years ago with pictures of the same city today to understand the Asian growth story. Well, if you did the same with Sao Paulo, the two pictures would look identical. And that is why you have students and workers protesting in the streets across the country. As an investor, I would be quite encouraged. The middle class just came on board, with 40 million people demanding an end to political corruption. Importantly, too, they are demanding investment in infrastructure, which is exactly why there is a huge investment opportunity. Today’s social instability can be viewed in different ways, but I would encourage anyone to focus on what it is doing to make Brazil a more efficient and better country. Anyone who invested in Brazilian equities through an ETF over the last three years will have had a negative return. However, as Freddie mentioned in regard to China, the difference in return between passive and actively managed funds has been sizeable. If you were invested in utilities or government-linked companies, you would have experienced a really negative return. But if you were invested in consumer stocks, infrastructure or credit, you would have enjoyed a positive return. So being a knowledgeable, regional player can make a big difference. From a fund manager’s point of view, Brazil is a big retail market. As a nation, we have always invested in mutual funds. The 2008 crisis was a great test for the industry, but

Asia gross national savings (% of GDP), 2012 estimates

60% 50%

50%

44%

40% 33%

32%

31%

28%

31%

Thailand

24%

32%

Taiwan

27%

South Korea

30%

24%

20% 10% 0%

US gross national savings (13%)

Source: International Monetary Fund, World Economic Outlook Database, October 2012.

Singapore

Philippines

Malaysia

Indonesia

India

Hong Kong

China

Australia

EU gross national savings (19%)

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Latin America gross national savings (% of GDP), 2012 ACT

24%

25% 21% 20%

15%

23%

20%

15%

10%

5%

0% Peru

Mexico

Colombia*

Chile

Brazil

Latin America and CCA region gross natinal savings (20%)

US gross national savings (13%)

Source: International Monetary Fund, World Economic Outlook Database, April 2013. Note: Colombia data is 2012 estimate.

no bank, fund or asset manager failed. In fact, assets went on growing. Today, there are some very high-profile, thirdparty funds being distributed locally.

Brazil’s, and their interest rates not so high. As a result, there is a lot more interest in having global exposure. Brazil, by comparison, is a tricky market, but the opportunities abound.

One hurdle for the mutual fund industry is Brazil’s high interest rates. Today they are 8%, but 10.5% to 11% is already priced in for the first quarter of 2014. This is something you cannot escape. And for international asset managers interested in competing in the Brazilian market, there is another hurdle: you can only do so through a feeder fund. And that feeder fund has to be set up in a format that only allows clients with a minimum USD500,000 to invest.

Post-match analysis Both regions have major attractions for international fund managers seeking to expand their distribution footprint.

Selling to Brazil’s pension funds is also a difficult business — because interest rates play a large part in the equation. Every year, pension funds are required to pursue what is termed the “quota of return”. This is a little less than the interest rate available on public or government bonds. So there is no incentive for pension funds to diversify. In fact, there is every reason for them not to diversify. In other countries, such as Chile, Peru or Colombia, the markets are quite open. Their local markets are not so big as

In the short-term, Asia offers greater retail market opportunities, provided fund managers can establish strong distribution channels in those countries where banks dominate the retail market. But perhaps the biggest lure in both regions is a fast-developing pensions industry. In Asia, pension assets are set to mushroom in country after country, opening windows of opportunity for fund managers who can demonstrate their international expertise. In Latin America, pension funds in a number of countries are increasing their overseas exposure and focusing on UCITS funds as their preferred medium. Brazil’s pension funds lag those in a number of other countries, but they present a big opportunity for those prepared to play a patient game.

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For more information Asia Mathew Kathayanat +44 (0) 20 7986 7523 [email protected] EMEA Cathal O’Daly +353 (1) 622 6260 [email protected] Latin America Marcia RothsChild +1 (212) 816 6478 [email protected]

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