Peru has become a beacon of macroeconomic stability in Latin America, with top-notch credit ratings and an admirable inflation record. However, while the Lima Stock Exchange (Bolsa de Valores de Lima, BVL) is one of the oldest among Latin America’s major economies, having been founded in 1860, it is also one of the smallest. The development of Peru’s capital markets has not kept pace with the development of the overall economy in recent years. In 2015 index provider MSCI – which international funds use to gauge the risk and quality of the world’s stock markets – considered downgrading Peru from “emerging” to “frontier” market status due to low liquidity. A set of reforms eventually consolidated Peru’s status as an emerging market, but the spectre of illiquidity continues to haunt capital markets in the country, and remains a problem for both debt and equity markets.
At the root of this is the fact that Peruvian capital markets remain limited relative to the size of the country. While the economy has increased in size three-fold since the turn of the century, capital markets have not proved able to emulate this growth. With trading volumes falling again in 2018, it is clear that markets need to see more dynamic growth in terms of both size and liquidity.
By far the most important investment funds in Peru are the privately managed pension funds known as pension fund administrators (Administradoras de Fondos de Pensiones, AFP), whose investment portfolios hit a record combined high of PEN162.2bn ($49.1bn) in March 2019, according to figures from the Banco Central de Reserva del Perú (BCRP), the central bank.
There are four AFPs: Habitat, Integra, Prima and Profuturo, with Integra and Profuturo having bought the assets of the fifth player, Horizonte, in 2013. This consolidation did not help an already illiquid market, and pension funds are far less active in the local stock market than they used to be, according to Jorge Ramos, CEO of BBVA Continental Bolsa, the equity brokerage arm of the Spanish lender’s Peruvian subsidiary. “The main reason for this is that their foreign investment limits have been raised,” Ramos told OBG. Indeed, BCRP has been steadily raising this limit ever since the start of the century, when the AFPs were only allowed to invest 7.5% of their portfolios outside Peru. BCRP last announced an increase in the foreign investment limits in July 2018, when it said that, as of September, the pension funds would be allowed to invest 50% of their assets abroad.
This increase, which was designed to encourage a greater diversification in AFPs’ portfolios, will give the funds $480m more to invest abroad, according to the BCRP. Since this announcement, these funds have increased their holdings outside Peru from 44.9% of their portfolios to 48.4% as of March 2019, an all-time high which equates to just under a nine-point increase against March 2017. Though the portion of AFP portfolios dedicated to shares in financial companies actually reach its highest-ever level of 3% in January 2019, the pension funds have significantly reduced their exposure to Peruvian non-financial corporates. From a peak of 45.5% in 2007, as of March 2019 just 8.3% of AFP assets were shares and investments in Peruvian non-financial companies. The percentage dropped to single figures in February 2015 and never recovered. “AFPs do hold a significant amount of shares, but they tend to stick to their positions and barely trade,” Ramos told OBG.
Next in line are the insurance companies, of which there are 20 operating in Peru. This industry grew by 13.6% in 2018, as measured by total net premium, to PEN12.868bn ($3.9bn). There are also mutual funds, a product that has grown in recent years, albeit only gradually, but this growth stalled in 2018. “Retail participation via mutual funds has been largely flat,” said Ramos. “The political situation in Peru was particularly off-putting for retail investors, as they know that stock markets are very sensitive to the news flow.” According to Peru’s Association of Mutual Fund Managers, after a strong 2017 assets under management by the country’s mutual funds grew only marginally in 2018. The association blamed the increased interest rate environment, though predicted strong growth in assets in 2019 thanks to new flexible funds, structured funds and funds of funds.
Indeed, as global market sentiment improved, so too did the size of the mutual fund market, which increased to PEN30.3bn ($9.2bn) as of the end of March 2019. In dollar terms, however, total assets under management by the mutual funds at that date remained 1.8% lower than a year earlier. Furthermore, investors in mutual funds continue to prefer debt products to stocks, with some 67.9% of the money invested in mutual funds being for debt-only products as of March 2019, with just 0.9% for stocks only, though 1.2% of the money invested goes to mixed strategies. Another possible source of concern is the fact that the number of participants in the industry has decreased in recent months, even as total assets increased. The number was down to 434,779 in March 2019, from a peak of 450,208 in April 2018.
Foreign investors accounted for 33.5% of the BVL as of March 2019, a level that has remained more or less stable for four years. In 2013 foreign participation in the market peaked at 41.4%, but gradually declined over the next two years. Of these investors, 43.8% were from the US and 20.9% from Panama.
Like most emerging market financial assets, Peruvian stocks endured a challenging 2018, amid rate hikes from the US Federal Reserve and global monetary tightening, before rebounding at the start of 2019 in line with improving global sentiment and metal prices. Traditionally, the performance of the BVL has been closely correlated with the performance of metal prices and mining companies, and this was certainly the case throughout 2018.
In 2018 the price of copper – the most significant metal for the Peruvian economy – fell by 17.5%, while zinc dropped by 24.5%, lead by 19.2% and silver by 9.6%. Even gold prices slipped by 1.9%. Despite shares in financial and consumer companies appreciating by 12.2% and 11.5%, respectively, in 2018, a 19.9% decline in the price of mining company shares led the S&P/BVL Peru General Index to a 3.12% fall overall in local currency terms. In dollar terms, it fell by 6.71%.
Public service firms lost 4.6% of their value, while that of industrial companies dropped by 3.8%. The so-called “junior” segment of the stock exchange, which is the most volatile and tends to follow broader market trends very closely, fell by 32.8% in 2018. This led the market capitalisation of the stock market to fall during the year from $162.4bn to $142.4bn. In local currency terms, the decline was less dramatic, from PEN526.4bn ($159.3bn) to PEN479.3bn ($145.1bn).
However, the first quarter brought important improvements. The Peru General Index increased by 9.03% in the first three months of 2019, driven by a 13% appreciation in mining shares and the fact that consumer companies were up by 14.1%. Marco Contreras, head of research at local broker Kallpa Securities, told OBG that he expects this trend to continue. “At the moment we are expecting the BVL to end 2019 up by 10-15%,” he said. “However, this very much depends on the international environment and the outcome of trade talks between China and the US.” These talks are likely to affect the price of copper, Peru’s biggest export. “Given that 35-40% of the exchange is mining companies, that has a big influence on performance,” Contreras said.
If 2019 has shown promise in terms of asset performance, concerns have only grown regarding low trading volumes and liquidity in the market. After averaging $25.07m per day in 2017, average daily trading volumes in equity products dropped sharply to $13.51m in 2018, amid lower risk appetite. Transactions in mining shares were mostly to blame, with the number of trades in these securities slumping from 48,593 in 2017 to 27,452.
Even as sentiment has improved in 2019, the average daily trading volume in equity products has continued to fall, to $12.02m per day in the first quarter. Some $757m of equity trading took place in the first quarter of 2019, compared to $883m in the same period in 2018. In terms of number of transactions there was an even sharper fall of 28%, from 31,140 to 22,420. This is a much lower ratio-to-GDP than other comparable markets in the region, such as Brazil, Mexico, Colombia and Chile. There was at least a slight improvement in fixed-income trading volumes in 2018, continuing a trend that began in 2014, thanks mainly to greater movement in public Treasury notes. Debt trading increased from PEN6.25bn ($1.9bn) to PEN6.79bn ($2.1bn) between 2017 and 2018.
Capital Markets Committee
To tackle this issue, in 2018 the Stock Exchange Superintendence (Superintendencia del Mercado de Valores, SMV) created a committee to investigate the causes of the limited growth in Peru’s capital markets. Led by Jose Manuel Peschiera, the committee first met in August 2018. It brings together associations of pension funds, insurance companies, investment managers and mutual funds, as well as brokerage houses and the BVL. Topics for discussion include creating an investment culture, the development of new products, market infrastructure and financial inclusion. At the third meeting in October 2018, World Bank capital markets specialist Ana Fiorella Carvajal was present, as the committee considered receiving consultancy from the multilateral institution (see analysis).
The BVL has partially attributed reduced trading volumes in 2018 to the “passivity and apathy” of investors in a context of uncertainty and risk aversion; however, challenging global factors and greater volatility do not necessarily lead to lower volumes. Indeed, as the World Federation of Exchanges highlighted in its 2018 report, amid the declines in market valuations, the presence of high volatility meant that trading activity across the globe increased notably in 2018, rising by 11.5% against the previous year in terms of volume of trade.
In 2018 the BVL published the Global Master Securities Lending Agreement in the hope of encouraging international investors to participate in securities lending and short selling, thus increasing liquidity. However, shorting remains a rare practice. “Being unable to short stocks is definitely a problem in Peru,” Ramos told OBG. “In periods of volatility, you do not have the option of going short and taking advantage of these falls in the market. The regulation is there but in practice it does not work, because we still do not have institutions willing and able to lend the stock.”
Although the BVL registered 11 new issuers during 2018, including debt and equity instruments, the total number of companies listed dropped from 284 to 273. This is also a factor behind lower liquidity. Alberto Arispe, CEO of Kallpa Securities, calls it a problematic cycle. “Given that Peru has such a small capital market, demand for initial public offerings is not particularly high and there are no new issuers,” he told OBG. “This makes it hard to increase liquidity.” Consequently, international funds that could inject this liquidity do not enter the market in great volume, precisely due to the lack of liquidity. In this light, it is possible that parts of Peru’s corporate sector do not view the equity markets as a real alternative for fundraising, because of what is perceived as a weak secondary market.
December 2018 brought some very welcome action when FIBRA Prime, Peru’s first real estate investment trust (REIT), issued $22m of stock. This followed in the footsteps of Mexico, which has developed its own version of the REIT product that has become common in the US. This type of product may help to open up capital markets, as it does not require large buying tickets. More than 100 retail investors participated in the first issue.
FIBRA Prime is a $500m programme and a second issue could be imminent, but more education about the product could be needed to reach higher levels, according to Arispe. “The emergence of new products such as REITS is certainly a positive for the development of the market, and now we need these deals to be larger,” he said. Hugo Perea, then-deputy minister of finance, told local media after the deal that REITS should help to channel greater investment flows towards capital markets.
Peru’s domestic bond markets generally serve their purpose for the country’s larger corporates, though they also suffer from the same poor secondary liquidity that afflicts stock markets, given the limited number of players. Beyond bank loans, the debt-raising options for corporates are private or public offerings, with greater documentation requirements for public offerings regulated by the SMV. These require the publication of quarterly results, as well as two credit ratings.
Private placements are only available to institutional investors and offer issuers greater privacy, but need to be registered with the Superintendence of Banking, Insurance and AFP – which is the financial regulator – to be bought by Peruvian pension funds. These investors and insurance companies do, however, require borrowers to have at least one credit rating. In terms of their preferred maturities, investors in the Peruvian bond market are highly segmented by type. Mutual funds tend to look for short-dated paper, up to a maximum of five years, while AFPs generally buy bonds that expire in seven to 10 years. To better match their liabilities, insurance companies seek paper with a maturity of 10 years or more.
As of 2018 pension funds held around 62% of the $76.3bn of funds invested in Peru’s bond market. Government entities owned around 13%, insurance companies 13% and mutual funds 12%. Such is the segmented nature of the investor base that certain pricing dynamics in the Peruvian bond market would look unusual to those well versed in international markets. “Often it is cheaper – in terms of the spread of government bonds – to issue at a longer maturity, in order to make the most of demand from insurance companies,” Eduardo Chueca, head of capital market debt at BBVA Continental, told OBG. The typical size of a debt issue in the Peruvian market is in the $30m-50m range, but up to $120m-140m is possible.
With AFPs representing the largest chunk of the market, companies can raise larger sums of money if they issue at longer maturities, with a deal size of $50m-70m generally possible for three- to five-year issues, but up to $140m available with a maturity of seven years or more. Total primary debt issuance, having reached $1.74bn in 2016 and edged slightly lower to $1.71bn in 2017, dropped more sharply to $1.35bn in 2018. Historically speaking, Peru has had a dual-currency bond market, but investors now strongly prefer local currency over dollars, and in 2018 just $24m of the $1.32bn issued was in dollars. However, in the first quarter of 2019 there were 19 public debt offerings, raising a combined total of $394.3m, which is more than double the $168.2m raised over the equivalent period in 2018.
The most recent issuances have been from companies looking to repay existing liabilities. “Peru’s bond market is dominated by refinancing trade at the moment,” Gonzalo Rojas Fernández, executive director for debt capital markets at BBVA Continental, told OBG. “Corporates have their investment plans somewhat on hold, infrastructure projects are not materialising very quickly, and the mergers and acquisitions market is quiet.” The existence of the private placement market means that it is not always easy to measure how Peruvian companies are selling bonds. Chueca said that BBVA Continental is “always looking to encourage new issuers” into the bond market, but that “most of the recent debut issuers have opted for private deals”. One encouraging development is that the Ministry of Economy and Finance’s work in extending the local sovereign bond curve, combined with Peru’s continued macroeconomic stability, has allowed corporates to issue debt with later maturity dates. In June 2017 energy transmission company Conelsur raised PEN113.5m (S34.4m) of 30-year paper in the longest-dated trade ever to take place in the Peruvian market. Stability in the currency also allowed two Peruvian issuers – Telefónica del Perú and Alicorp – to become the first Latin American companies to sell local currency-denominated bonds on the international market in 2019. Both companies opted for eight-year amortising deals with average maturities of seven years, and more than half of the demand came from non-Peruvian investors.
“We would love to see more issuers look to issue local currency abroad, so that we could have local investment competing with foreign buyers looking at local currency in emerging markets,” Chueca told OBG. “The obstacle is that you need a deal of PEN1bn ($302.7m) or more to be able issue abroad.”
Throughout much of Latin America, international bond investors have traditionally proved more receptive than domestic markets to lower-rated borrowers, as long as they issue in dollars. However, bankers say that while appetite is undoubtedly strongest for companies rated “AAA” on the local scale, the Peruvian market is becoming more receptive to lower-rated paper, with companies that have a single “A” rating now regularly issuing.
For smaller companies, the SMV has created the Alternative Securities Market (Mercado Alternativo de Valores, MAV) to allow firms with an annual income of below PEN350m ($105.9m) to access bond market financing with easier documentation requirements than the main market. Arispe told OBG that the market is a positive development, as it allows smaller companies to issue around $20m. “However, to raise more than that you need the participation of larger funds that do not want exposure to riskier or smaller companies,” he added. Agricultural company Eco-Acuícola’s $14.93m deal was a notable success on the MAV in 2018.
While both the size and growth of the BVL are relatively limited when compared to Peru’s overall economy, the country’s macroeconomic stability stands it in good stead for its debt and equity markets to develop and mature over the coming years. Domestically, through efforts to increase penetration, the country’s currently high market concentration should give way to more diverse participation from individuals and companies of all sizes and sectors. One of the cornerstones to this will be ensuring the business community, and the population as a whole, are made more aware of the financial benefits that participating in capital markets can bring.
In global terms, the challenge of generating greater participation in the BVL will be closely linked to prevailing emerging market sentiment going forward. This in turn will be heavily influenced by the long-term outcome of the China-US trade war. Looking to the 2020s, question marks remain as to whether Peru will eventually be able to bolster the size and penetration of its capital markets in a way that more closely reflects the scope and dynamism of its economy.