1. Pension fund investment performance. The cases of Argentina, Colombia, Chile and Peru Sebastián Auguste and Daniel Artana FAIP Seminar “Pension Fund Perspectives” Santiago - Chile, 18th May 2006

2. Capitalization system return (2000-2005)

3. Indexes adjusted for risk compared with the pay- as-you-go system over a given period of time

4. Work index 1.Problems to be solved 2.Studies carried out for the region 3.Estimations made in this study 4.Conclusions FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

5. Problem 1: How to measure the performance of the AFPs as portfolio managers 1.What to measure: Return adjusted for risk Absolute or relative risk is the usual There is some evidence that it is also relevant to look at other points of the distribution 2.How to measure it Indexes (Sharpe) Econometric estimations of systemic risk Problems with these measurements: Other points of the distribution may be important Biasses in the estimation as a result of problems in the definition of the market portfolio Restrictions in terms of information or market size FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

6. Problem 1: How to measure the performance of the AFPs as portfolio managers Option: Characteristic based studies The alternative portfolio is put together by replacing the return of certain selected shares by others in the share fund, to see whether the administrator, within his restrictions, chose those with the best performance This is an interesting approach, to overcome the problem posed by the investment regulations affecting the AFPs FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

7. Problem 2: With what to compare the performance of the AFPs as portfolio managers 1.The AFPs have investment regulations that limit their possibilities as portfolio managers 2.The size and depth of the domestic market is insufficient to allow them to replicate share indexes and restricts certain investment options 3.Problems of valuation of public bonds (Argentina, Colombia until recently). This affects comparisons with other investors, which always have to value at market rates FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

8. Problem 2: With what to compare the performance of the AFPs as portfolio managers 4.The AFPs are “multi-portfolio” investors while the mutual funds are generally not. This allows the AFPs to “exploit” the co-variance between the sub-portfolios 5.Investment Horizon. The AFP is a long-term investor. This should lead to a portolio that is adapted on the basis of the age of the individual. A forced single portfolio will be less than the best. Switches encourage the AFP to look at short-term returns 6.Future obligations. Minimum pension or minimum return. These affect incentives (to take greater risks or produce the pack effect). FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

9. Problem 2: With what to compare the performance of the AFPs as portfolio managers 7.Other assets. The social security fund may be people’s only relevant asset. But if there are others (housing, human capital), should the best investment strategy include the relation between the different assets? 8.Problems for comparison (in addition to information limitations and valuation problems caused by the Argentine crisis): –AFP gross return of commissions and gross or net of operating expenses, depending on the country –Mutual Fund: net return in both cases –Passive indexes: gross in both cases FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

10. Studies carried out for the region 1.Chilean regulations are costly, equivalent to a 5% tax on the accumulated fund (Berstein and Chumacero, 2003). But the AFPs may “undo” the regulation, reassigning investments within the sub-portfolio (Chisari and Dal Bó, 1996 show evidence for Argentina). At the same time, limits per instrument may prevent reassignation. FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

11. Studies carried out for the region 2.The AFPs have better performance adjusted for risk than mutual funds (Srinivas and Yermo 1999 for various countries in the region) and there is a “pack” effect. They make a partial characteristic based analysis, replacing parts of the AFPs’ sub- portolios with mutual funds or passives indexes It is impossible to distinguish efficiency as portfolio managers from the effect of the regulations They do not correct for valuation problems in Argentina They do not consider that passives indexes cannot always be replicated FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

12. Studies carried out for the region 3.Members are adversely affected because they have few options and because of the limits on investment abroad (Yermo, 2004 for various countries in the region). Comparison with certain problems (there is no correction for valuation differences between countries, and not always correction for risk) 4.In Chile’s case there is loyalty because the medium- sized AFPs obtain better yields than the others (Walker, 1993; Arrau and Chumacero, 1997 and Zurita and Jara, 1999). 5.None of the previous studies consider that members have other assets (housing, human capital) FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

13. The estimations of this study 1.Data: Real monthly return (adjusted by the CPI) before commissions. In the case of mutual funds, the commission was added to the net return. 2.Various estimations Return adjusted for risk in the 4 countries Analysis to look at loyalty Markowitz Efficiency Boundaries Characteristic based approach Preliminary evidence on commissions and return and on the correlation with the prices of properties FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

14. Risk-adjusted return (2000-2005)

15. Loyalty analysis 1.We analyse rates of return, adjusted for risk, for movable periods of 60 months for each AFP in each country. 2.A statistical test is made to determine whether there are differences with the average of the system of each country (simple and weighted) 3.The results show loyalty in all four countries 4.This is marked in the cases of Argentina and Peru, less so in Chile, and in Colombia it is explained by the performance of one AFP FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

16. Markowitz Boundary- Chile 2000-2005

17. Markowitz Boundary - Peru

18. Markowitz Boundary - Argentina

19. Characteristic based approach Two measures were defined to test the AFPs’ ability to improve their performance within the regulations currently in force: Varying the weight of each sub-portfolio versus a portfolio with fixed weights, Comparing with a portfolio with the same sub- portfolios, but replacing the return with that obtained by mutual funds FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

20. Characteristic based approach- Peru In the case of Peru, part of the AFPs’ portfolio (80%) was broken down into three sub- portfolios: fixed income, money market and shares The evidence shows that the AFPs could improve the performance of the funds by bearing in mind the correlations between different types of assets and adjusting the weight of each sub-portfolio Or reassigning assets within each sub-portfolio to “undo”, at least partially, the effect of regulation FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

21. Characteristic based approach- Chile In the case of Chile, the AFP portfolio was broken down into five sub-portfolios: money market, local shares, local bonds, international shares and international bonds The evidence shows that the AFPs achieved a return similar to the benchmark portfolio of mutual funds, but a higher return adjusted for risk, even when compared with “winning” mutual funds FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

22. Evidence on commissions and other assets In all four countries there is some evidence that the differences in commissions charged by the AFPs are not explained by differences in returns The information on prices of properties is scarce (Argentina and with some limitations Peru) but the available series show a negative correlation with the AFPs’ returns ( -0.18 in Argentina and –0.04 in Peru). There is some evidence that the ranking of the AFJPs in Argentina would alter if the fact that members have other assets, such as property, is taken into account

23. Conclusions The performance of the AFPs as portfolio managers has been good The differences between countries in return adjusted for risk are explained to a large extent by each country’s risk. The AFPs exploit the possibilities within each sub-portfolio to reduce the cost of regulation It is important to study in more depth the correlation with the person’s other assets and the evolution of the net return of commissions FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar

24. Suggestions The AFPs are “doing a good job” within the regulations that they face. But these should be reviewed: –The multi-portfolio makes it possible to increase the efficiency of the system and the welfare of the workers –Portfolios have a strong bias towards local investments (because of the limits on investment abroad) FIEL daniel@fiel.org.ar sauguste@fiel.org.ardaniel@fiel.org.ar