Peru is one of Latin America's best performing economies. Nick Fitzpatrick looks at supporting factors for investment management there, including the growing middle class and easier access to offshore investment.
To live in Peru is to be rugged. The difficulty of absorbing enough oxygen when you are a farmer living in the Andean mountain range is attested to by natural selection, which has favoured the barrel-chested.
A degree of hardiness is useful in other areas, too. The nation is distinguished by its diversity of landscape, which sees the Andes flanked by the Pacific coastal region on one side, and the steamy “selva”, or rainforest, on the other.
Yet wherever they have chosen to build their abodes, the Peruvians are now busy improving them with a bit of do-it-yourself and fetching decoration. In what is probably another sign of how the emerging markets are raising a middle class, the home improvement outlets of Falabella, a South American department store chain, saw revenue in Peru grow by 41% in 2011, more than in Chile, Argentina and Colombia – its other countries of operations – where growth ranged from 12% to 22%.
In fact, to see which way Peru’s social and economic winds are blowing it’s worth looking more closely at the financials of Falabella. The Chilean headquartered firm saw income from its Peruvian supermarkets increase by 30% in 2011, more than Chile (15%), the only other country of operation where the company has supermarkets.
Meanwhile, visitors to Fallabella’s Peruvian shopping malls were up 57% to 33 million people, again more than in Chile, albeit from a much smaller base.
The surge in consumption around domesticity appears to reflect a rise in the number of Peruvians setting up home. Having one of the highest levels of “household formation” in the region is a notable demographic trend for Keith Rapp, a founder of Andean Investment Partners in Lima, Peru’s capital. He is a real estate investor with money from European and US professional clients.
Obtaining a 20- to 30-year mortgage in local currency is no longer a problem for many Peruvians, thanks ultimately to Peru’s investment-grade credit rating. S&P upgraded Peru from BBB- to BBB with a stable outlook in August 2011. Fitch followed and the subsequent ability of Peru’s banks to obtain finance has grown.
But where there is a rising middle class with easier access to mortgages, is there also a residential property bubble not far behind? Not in Peru, according to Rapp.
He notes, that although land values have increased by 300% to 500% in the past five years, banks apply exacting lending criteria by requiring new mortgage applicants to make a 20% down payment for a house purchase.
A similar argument is used by those that dismiss ongoing fears about a property bubble in China.
Rapp adds: “There’s a huge deficit in the residential and commercial real estate space.” Easier access to finance has benefited the commercial property sector too and it is in commercial property where Andean Investment Partners has most of its investments. Rapp says there are “class A” tenants (large firms, like the pan-regional Lan Airlines) and “class B” tenants, or smaller firms. It is through this latter group that the rise in the middle class in Peru is most vividly reflected.
“The class B occupants of the office sector tend to be small and medium-sized businesses that may have previously operated out of a smaller building, or even a house. They can get the financing to do that now.”
These businesses range from small banks, construction firms, tourism and law firms. There are also light manufacturing and textile operations.
It sounds like a dynamic yet still developing economy and though the presence of a looming property bubble may not be detectable, what is detectable, unsurprisingly, is interest from private equity firms.
There are already local private equity funds in Peru, like those run by Enfoca Investments, which has more than $600 billion under management and invested there. It has raised much of its money from Peruvian pension funds, but also gained investment from the International Finance Corporation (IFC), a member of the World Bank Group and the largest global development institution focused on the private sector in developing countries.
The IFC has also invested in a fund of London-based Greenpark Capital, which is set to deepen the tint of private equity investing in Peru by looking at opportunities in the “secondaries” market.
It is understood that as the firm starts to invest in Peru, it is looking to raise another $400 million from investors on top of a $100 million commitment from the IFC.
Investing in the secondaries market means that Greenpark buys out an investor that is invested in an existing private equity fund and is unable to leave without selling the stake due to the “lock-in” periods of private equity vehicles, which last ten years.
Greenpark will be targeting mid-market secondaries. Eric Pathé, investment director, says Greenpark feels this segment of the market has become a viable business for private equity funds that invest in emerging markets. It was thought to be too early for secondaries investment in emerging markets due to the size of the industry. Pathe says: “You need a pool of funds that have been in existence for some time and limited partners who want to get out. We think the time is ripe as the private equity industry is now mature enough in the emerging markets.”
An investor may leave a private equity fund to change asset allocation rather than because the fund is doing badly, says Pathé. And for investors, the fact that a secondaries fund is already invested in specific enterprises means they can see what kinds of businesses they are getting into as opposed to joining a fund at the capital-raising stage with no investments.
“We are bullish on Latin America. There are countries there that are growing very nicely. Colombia and Peru are obvious candidates and there is already a lot of private equity in these countries.”
Greenpark will be targeting Peru’s own pension fund market for investments, as well as potential clients in other markets.
Also focusing on the Peruvian pension fund market is Neuberger Berman, a US fund manager firm with business globally. In August 2011, it opened an office in Buenos Aires, Argentina, to deepen its Latin American business.
Neuberger, which is headed in Latin America by Maxi Rohm, looks at Peru as a key market along with Chile, Colombia, Mexico and Brazil.
“Peru’s institutional pension funds, insurance companies and even wealth managers are increasingly investing client assets offshore,” he says. “They are interested in equities, fixed income and even certain alternative strategies.”
Rohm says high-yield bonds, private equity, regional emerging market equities and US small caps are appealing to the institutional market.
In recent years, Peru’s pension fund regulator, the Superintendency of Banks, Securities and Pension Funds, has relaxed restrictions significantly for private pension funds to invest offshore. This has happened elsewhere in the region and Rohm says across the continent the offshore subset of investments is growing perhaps some 50% a year. In doing so, Peru is following in the footsteps of Chile, which has led the way in the region for pension fund development.
Peru’s private pensions system consists of four pension fund administrators, which have $30 billion of deposits. They are known as AFPs and employees have to elect one to be their provider.
“Pension funds tend to be very tactical in their international investment approach,” says Rohm. He adds that being accustomed to investing in emerging markets, pension funds in the region are comfortable with the associated risk-return profile.
Local equities may offer a more restricted menu. Many analysts will point out that the Peru stock market is weighted towards mining companies, which are tied to Peru’s main sources of wealth: copper and other raw materials.
The Lima Stock Exchange, or Bolsa de Valores de Lima, is one of the region’s less active markets with a capitalistion of $135 billion. This is smaller than Chile’s, which stands at around $316 billion, and Colombia’s stock market which stands at $254 billion. Only a small portion of shares in Peru’s 250 companies are traded with regularity.
Last year, Peru, Chile and Colombia created an Andean stock exchange, called the Mercado Integrado Latinoamericano, known as Mila, which may broaden its equities market in time (see box).
And if private equity investment in local firms grows, there could be more initial public offerings adding to the depth of the Lima exchange.
Peru looks set to be another exciting market in Latin America after Brazil, albeit one with a certain amount of ‘home improvement’ still to do. But looking at the pattern of Peruvian’s shopping habbits, they won’t mind that.
©2012 funds global