Capital market growth underscores the need for greater liquidity

The development of Peru’s capital markets continues apace, driven by the growing number of increasingly sophisticated local institutional investors. The growth of private pension fund administrators ( Administradoras de Fondos de Pensiones, AFPs), life insurance companies and mutual funds, as well as the emergence of local family offices, have all played a part in this evolution. Nevertheless, the markets’ lack of liquidity remains a major challenge. “Ours is a market that should not have liquidity of $15m per day,” said Christian Laub, president of the Lima Stock Exchange ( Bolsa de Valores de Lima, BVL) and CEO of Credicorp Capital. “We should be seeing this level reach $200m, $300m or $500m per day in the equity capital markets alone, which should then also be reflected in the bond, currency and derivatives markets.”

Recent Performance

Alejandro Rabanal, head of equity research at Credicorp Capital, summed up the market’s recent mixed performance, telling OBG, “In general, it is fair to say the high hopes we had as of 2013 for the following year in the Peruvian markets have not been realised. This has been due in part to the relative slowdown of China’s economy and the resulting decrease in copper prices. There has also been a divergence between the debt markets, where we have seen some positive activity in the past year, and the more subdued equity markets.”

The BVL started 2014 off poorly, with stock prices falling significantly on the withdrawal of monetary stimulus by the US Federal Reserve and the effect of geopolitical tensions surrounding the conflict in Ukraine. However, from the second quarter on, the Federal Reserve’s decision to postpone interest rate hikes in light of weaker-than-expected US employment figures, along with a further cut to interest rates by the European Central Bank and the announcement of economic stimulus measures by the Peruvian Ministry of Finance, helped produce a rally in the market. BBVA, Peru’s second-largest bank, also partly credited the recovery of China’s economy with boosting the performance of Peruvian mining stocks, thanks to a resurgence in global copper prices.

This was reflected in the BVL General Index (Índice General de la Bolsa de Valores de Lima, IGBVL), which climbed 3200 points between March 26 and September 8, 2014, to close at 17,249 points. However, the IGBVL subsequently fell by more than 1000 points in the space of a few days, closing at 16,227 by the end of September 2014, a 3% overall rise for the first nine months of the year. Meanwhile, the BVL Selective Index was down 2.4% over the same period. The BVL has seen moderate volatility and subdued trading volumes throughout 2014, which the exchange attributed to enduring risk aversion on the part of investors.

Top Performers

Mining, banking and utilities were the strongest performers on the BVL in the first nine months of 2014, rising 25.1%, 14.5% and 11.3%, respectively, while the industrial sector declined by 25.1%, which BBVA attributed to the slowdown in the economy at large. Of the IGBVL stocks, Atacocha B was the best performer over the period, climbing 143.1%, followed by Rio Alto (up 48.5%) and common Milpo stock (up 47.0%). Meanwhile, the biggest drops were seen by Maple Energy (down 86.8%), Minera IRL (down 32.4%) and Graña y Montero (down 25.2%).

New Listings

As of December 2014, there had been no initial public offerings (IPOs) on the BVL for the year; however, Rabanal was optimistic that there will be at least one at the beginning of 2015. The long-awaited IPO of state oil firm Petroperú, expected in 2015, is the big prize financiers are looking for to accelerate the development of the equities market. “The government is keen to list state-owned enterprises like Petroperú, based on the positive experiences of Brazil and Colombia in listing their national oil companies,” Rabanal told OBG. There are hopes that a successful listing could lead to IPOs of other government enterprises, such as electricity providers.

Roberto Flores, the head of strategy and economic research at Inteligo, a stock brokerage owned by Grupo Interbank, agreed that the listing of stateowned enterprises would be a big step forwards for Peru’s capital markets, though he also pointed out that while this had been discussed for the better part of the past decade, it had yet to materialise. “There are also certain cultural obstacles we have to overcome, such as an instinctive reluctance on the part of Peruvian company bosses – particularly in the public sector – to relinquish control of their companies, which is what a listing partly entails,” suggested Flores.

Raising Awareness

“We need to see a greater number of companies issuing stock,” Aldo Ferrini, deputy CEO of AFP Integra, told OBG, predicting this would naturally occur as Peruvian companies grow larger and more international. “We have a large number of companies in Peru that are currently family-owned. Cultural changes occurring within these companies, often triggered by generational transitions in their management, are prompting them to seek expansion at home and abroad, thus transforming themselves from large businesses into fully-fledged corporates that may seek financing by issuing stock,” Ferrini said.

Flores highlighted the Avanza BVL (“Progress BVL”) programme as a worthwhile initiative to raise capital markets awareness among Peruvian companies. “One element of the programme consists of providing training to small and medium firms about how the capital markets work. We have many companies at present that have no idea what the capital markets are. The second element of the programme revolves around showing companies specifically how they could use the capital markets to develop their businesses. The programme’s aim is to prepare companies to list on the Alternative Stock Exchange (Mercado Alternativo de Valores, MAV).” As of December 2014, five companies had issued bonds on the MAV, with another four planning issues in the near future, according to Lilian Rocca, superintendent of Peru’s stock market.

Liquidity

However, Luis Manuel Ordoñez, head of research at Inteligo, told OBG there was a limit to the impact that such initiatives could have in the absence of greater liquidity. “A small company looking at raising capital by listing on the BVL may be disappointed by the level of demand it finds for its shares, because investors will be wary of purchasing such shares due to the illiquidity of the secondary market,” he said.

“There is no getting away from the fact that Peru’s capital markets are illiquid. Recent years have seen interesting developments on the debt capital market side, but the market still lacks depth,” Ferrini told OBG. “This situation is recognised by all parties – the regulator, investors, brokers and the stock exchange.”

Rabanal told OBG that the lifting of restrictions on the proportion of Peruvian pension fund assets that can be invested abroad (see Insurance chapter), while a positive development in its own right, has aggravated the problem of illiquidity in the market.

Foreign Opportunity

The Latin American Integrated Market (Mercado Integrado Latinoamericano, MILA) is one initiative that is expected to play an important role in increasing the liquidity of Peru’s capital markets (see Economy chapter). Indeed, Peru stands to benefit the most from the MILA, as its stock market is the smallest and most illiquid of the group – which includes Peru, Chile and Colombia. Mexico is set to join after signing a cooperative agreement in August 2014, but has not yet been integrated.

Strong demand for Peruvian companies’ American depositary receipts (ADRs) is evidence of the foreign interest in Peru’s capital markets that the MILA project seeks to build on. “The volume of Peruvian ADRs traded in New York is greater than that of Colombian ADRs, despite the Colombian stock market having a much greater capitalisation,” Ordoñez told OBG.

Reforms

While international initiatives like the MILA can contribute to the country’s capital markets development, domestic reforms are needed as well. This is particularly true with respect to the current capital gains tax regime, in place since 2012, which renders the process of investing in Peru more expensive than elsewhere in the region. “The 5% capital gains tax payable on exchange earnings acts as a disincentive to investing in the Peruvian stock market,” Rabanal told OBG. However, he expressed hope that the government would repeal the tax, especially as it has not produced the desired revenues since being introduced.

In addition to making Peru less competitive than Colombia and Chile, the country’s capital gains tax also places the local stock market at a disadvantage in relation to markets in New York. “Say, for example, I was a fund manager in London who was looking to buy Credicorp stock. If I buy it in New York, I do not pay this tax, whereas if I buy it Lima I have to pay the tax,” explained Laub. In this sense, the capital gains tax hampers efforts to make Peru’s capital markets more liquid, and in part explains why between 10 and 15 times more Peruvian securities are traded on a daily basis in New York than in Lima.

Unlike the tax environment, Rabanal sees the 70% reduction in equity market fees charged by the BVL in November 2013 as a positive development for investors. “This reduction in fees was important but we have to do more,” Laub said. “Therefore, we are working with the government and the central bank to introduce a range of additional tax and regulatory measures to improve the markets.” Ferrini told OBG that institutional investors would also welcome the introduction of mechanisms for security lending and short-selling, which do not exist at present.

Retail Investors

On the demand side, more also needs to be done to develop the market for local retail investors. “The few retail investors that there are invest in the stock market through mutual funds. New technology platforms that make it easier for people to trade will help to encourage greater participation in the stock market by local investors. Tax reforms that encourage saving and investing are a further step that would help in this regard,” Ferrini told OBG. “One should also recognise that retail investors are typically market followers, so the performance of the stock market itself will be an important factor in attracting greater investment from this segment. What we have seen in the past is retail investors pile into the market when it is rising, and pull out when it falls.”

Public Bonds

Another area that has attracted the interest of retail investors is the Peruvian government bond market. Flores explained that the Peruvian government recognised market demand for short-term government debt and, therefore, started issuing notes with maturities of three, six, nine and twelve months in 2013. “These have been well-received, with the bid-to-cover ratio consistently above one,” Flores said.

Even so, the local market for Peruvian government debt continues to lack liquidity. “In Colombia, for instance, between $4bn and $5bn of government debt is traded per day, whereas the corresponding figure for Peru is between $60m and $70m, which is an enormous difference,” Laub told OBG. He attributed this lack of liquidity in part to the government’s prioritisation of long bond terms and low rates at the expense of making the creation of a liquid market in government debt an objective in its own right. “Longdated bonds of up to 40 years are clearly an efficient option from the government’s point of view, as they avoid refinancing risks,” Laub told OBG, “but they do not help to build a yield curve of bonds with differing maturities that the market needs in order to generate greater liquidity,” he explained.

Promoting capital markets liquidity matters because of the contribution these markets make to national economic growth. “Growth requires investment by companies, which must be financed somehow. This requires banks on the one hand and capital markets – both local and international – on the other hand. Even though the international capital markets will always exist, the country needs to develop a solid domestic market for the times when the international markets may not be supportive,” Laub said.

Private Equity

As a testament to investment’s role in broader national development, Flores described how private equity is helping improve local education. “Nexus Group, a Peruvian private equity firm, has recently invested in schools and universities. This is particularly welcome as the Peruvian education sector is in much need of investment,” Flores told OBG.

Private equity is an area that has attracted increasing investor interest, albeit starting from a small base. “The ability of pension funds to start investing in new asset classes from 2005 marked the start of a period of growth in Peruvian private equity. We now see an ever-increasing number of funds and investments being made in this area,” said Ordoñez, citing the 2012 acquisition of Aureos Capital – a Latin America and Africa-focused private equity firm – by the UAE’s Abraaj Capital as an example of growing foreign interest in Latin American private equity.

Venture Capital

The Peruvian private equity sector is presently focused more on buyouts than venture capital. “In the future, we would like to see more growth in venture capital, as ultimately these are the means by which private equity firms can create economic value – by backing entrepreneurs,” said Ordoñez.

“The reason why venture capital has not taken root in Peru is that the necessary conditions for entrepreneurs to develop businesses that would be attractive to venture capital firms do not exist yet,” Melvin Escudero, CEO of El Dorado Investments, told OBG. “Therefore, there is a need first to educate businesspeople, the financial sector and the government in order to foster these conditions,” Escudero explained.

Hedge Fund Support

Turning to foreign investors, Laub sees Peru increasingly being treated as an outperformer among its Latin American counterparts, in addition to emerging markets more generally, by investors betting on individual countries – hedge funds in particular. “While asset managers looking to cut their exposure to emerging markets in the current climate will typically reduce their investments in Peru in line with the rest of their emerging markets portfolio, hedge funds have the ability to be overweight in Peru,” explained Laub. As a result of this, Laub expects to see a decoupling in the performance of Peruvian securities from those of other emerging markets. “For instance, a hedge fund is able to differentiate in its positions between a market like Peru and one such as Brazil. Both are emerging markets, but Peru’s prospects are completely different from those of Brazil at present. We expect this sort of differentiation to protect Peru in the event that investors turn their backs on emerging markets,” said Laub.

Outlook

Thanks to all of the reasons that hedge funds and other investors are optimistic about Peru’s economic fundamentals, growth of the country as well as its companies should continue to drive the development of capital markets over the coming years.

To best support growth, regulators and other stakeholders will need to remain active in order to ensure that capital markets are able to develop to their full potential – with the issue of liquidity remaining a central concern – to allow Peruvian companies to secure similar levels of demand for their stocks and bonds in the local markets as they currently find offshore.