Pension fund in many emerging markets are under pressure because policymakers continue to allow savers to withdraw their money ahead of retirement. Juan Pablo Noziglia, CIO at Prima AFP in Peru explains the impact on one of the country’s largest funds as assets fall by half due to early withdrawals.
In the last couple of years, Peru’s second largest pension fund, Prima AFP, one of four privately run defined contribution funds that people can choose over a state-run defined benefit pension fund, has seen its assets under management slashed by almost half.
Before the pandemic, Prima AFP managed $18 billion but today this has fallen to around $9 billion, whittled away because policymakers have allowed beneficiaries to withdraw up to $5,000 a go in six different withdrawals through the pandemic and its aftermath.
“Over the last couple of years, we have lost 52 per cent of our assets due to laws allowing withdrawals,” says Juan Pablo Noziglia, chief investment officer at Prima AFP speaking to Top1000funds.com from the fund’s Lima headquarters. “It’s the equivalent to a run on the bank.”
Withdrawals sought to alleviate the emergency triggered by COVID, but subsequent approval of beneficiaries tapping their pension for funds a fourth, fifth and sixth time are in stark contrast to pre-pandemic policies. Before COVID the only way beneficiaries could access their savings was after they turned 55 as monthly benefit, or at the end of their working life when they are permitted to withdraw the bulk of their savings to use as they see fit.
Prima AFP’s story reveals how the impact of the pandemic and subsequent cost of living crisis on pensions systems in developing countries is starting to unravel. FitchRatings estimates Peruvians withdrew 8 per cent of GDP from their pensions in 2021, while in neighbouring Chile, although a fourth withdrawal proposal failed in April 2022, savers withdrew about $50 billion (16 per cent of 2021 GDP) between 2020-2021.
It’s a similar story in other emerging economies like South Africa where pension funds like the R2.3 trillion ($0.12 trillion) Government Employees’ Pension Fund, GEPF, and the R190 billion ($10 billion) Eskom Pension and Provident Fund (EPPF) wait to hear if the government will allow cash-strapped beneficiaries to drawdown their savings ahead of retirement.
In Peru, any halt on future withdrawals hangs on a decision from congress. A new cohort of policy makers responsible for shaping laws in the economic and budget commission are in the process of taking up office after which they will rule on submitted reforms to the pension system.
In the meantime, the future of pension funds like Prima AFP hangs in the balance, in marked contrast to Peru’s public pension fund which has not experienced any withdrawals.
“The public fund Oficina Nacional de Pensiones, ONP, has had zero withdrawals,” says Noziglia. “Because it is a defined benefit fund and a common pool, ONP can’t tell people how much they have saved and how much they can withdraw.”
the investment impact
Prima AFP offers beneficiaries four different asset allocations with different levels of risk, but mass withdrawals have had a dramatic impact on the pension fund’s ability to invest long term and diversify. Prima AFP used to comfortably lock up money in alternatives for ten years or longer, most of which was invested overseas in line with the fund’s ability to invest 50 per cent of assets abroad.
As withdrawals have gathered pace, Noziglia has had to change the allocation, selling down illiquid investments in buyout funds, secondaries and funds of funds and changing the portfolio construction. “As the withdrawals have come in, we have sold what we can rather than what we want.”
The problem lies in domestic liquidity constraints. The central bank has certainly tried to help. It has put in place measures to safeguard the local fixed income market by allowing pension funds to repo sovereign bonds (offering loans to pension funds guaranteed with sovereign bonds) thereby extending the time investors have to sell and are not forced sellers. Noziglia estimates the Peruvian bond market trades around $300 million a day, enough to allow investors “to move around” but at risk of crashing if Peru’s four DC pension funds on the hunt for liqudity all sold bonds on the same day.
As for the local equity market, although it has grown more liquid over time it only trades between $4-7 million a day. “One per cent of our fund accounts for around $90 million. I can’t go and sell the local market,” he says. In short, although he sells a patchwork of assets locally with the help of the central bank where he can, the bulk of the required liquidity has and will come from holdings outside Peru.
He’s just finished laying the groundwork in preparation for another liquidity call. This has involved working with specialist counterparties that allow the pension fund to be in a position to sell a large chunk of alternatives in secondary transactions if needed. “We are not keen on selling now, but if we have to, the door is open.”
In another, longer-term strategy, he is working with peers to educate people on the importance of Peru’s pension system but describes an uphill battle.
“Most people think we are pushing pensions because it gives us money,” he laments. “For the country as a whole, it makes no sense for people to reach the end of their working lives and retire with nothing in their accounts.” Although he’s encouraged by Peru’s healthier macro-economic picture, forecast growth and falling unemployment, he says the informal economy still dominates and getting people into the work place remains tough.
Peru’s ailing pension system is also having a knock on effect on the asset management sector where home grown firms are few and far between. Although local private debt managers are present, he says buyout and private equity asset managers as a whole are dying a slow and painful death compared to how the sector stood a decade ago. One of the problems is that although local companies may look “great on paper” unless they are regional champions, they struggle to attract buyers when they come to be sold.
“A lot of the problems in Peru are because of political instability,” he concludes.
