Capital market reforms and economic growth a boon for Peru's bourse

The Peruvian stock exchange, the Lima Stock Exchange (Bolsa de Valores de Lima, BVL), had a boom year in 2016, achieving one of the highest rates of return in the world. The main index, the Standard & Poor’s (S&P)/BVL Perú General, ended the year at 15,567 points, a gain of 58.1% on the previous year, according to the World Federation of Exchanges (WFE). This made it the second-best-performing bourse in the world in 2016, after Egypt, which gained around 76%.

In terms of the general index, the BVL’s performance ranked ahead of Argentina’s Bolsa, which gained 55.5%, and Brazil’s Bovespa, at 38.9%, according to WFE. It was also the best-performing stock exchange of the four countries of the Pacific Alliance – a trade group made up of Peru, Chile, Colombia and Mexico. For comparison, the New York Stock Exchange composite index registered a gain of 9% in 2016.

The BVL’s rally was a welcome contrast to 2015, when the general index slumped by around 30%. Roberto Flores, chief strategist and head of global macro research at Lima-based brokerage Inteligo, believes three main factors have been driving this recovery and will continue to be at work during 2017. “First, global metals prices are increasing, and although the BVL is now quite diversified, international investors are still drawn to it when mining is doing well,” he told OBG. “Second, the economy is recovering: in 2017 growth will be particularly strong in sectors linked to private consumption, favouring stocks in construction, retail and the power sector. And third, while global economic conditions remain uncertain, investors believe a number of emerging economies will do well.”

Emerging Market

Taking a long-term view, it is possible that in hindsight, 2015 will be looked back on as the year that the BVL confronted, and successfully addressed, a major threat to its development. Until 2012 the BVL had enjoyed the effects of a decade-long commodities boom that propelled mining stocks and investor interest upward. However, as the commodity cycle ended and metals prices eased in 2013-15, it seemed that the BVL had become trapped in a downward spiral of shrinking market capitalisation, falling trading volumes and a slumping share price index. Total traded volume, which had averaged the equivalent of 4.2% of GDP during the 2005-12 period, fell to a multi-year low of 1.2% of GDP in 2015, before beginning to recover, reaching 1.7% in 2016. Daily traded value followed a similar curve: it averaged $15.9m in 2012, but more than halved in subsequent years to $6m in 2015. In this case, too, there was a reversal of the trend in 2016, with average daily traded value rising to $8.8m.

Downgrade & Reforms

The threat to the BVL appeared to crystallise in August 2015, when the New York-based index provider MSCI said it was considering downgrading Peru from emerging market to frontier status. At that stage only three BVL stocks met MSCI’s emerging market investability criteria. Losing any one of them would have automatically led to a downgrade.

Such a change in status would have triggered estimated capital outflows of anywhere from $1.5bn to $5bn as many institutional investors who were unwilling or unable to assume frontier market risks adjusted their respective portfolios. “The threat of relegation to a lower division created a sense of urgency about the changes that needed to be made to deepen the market and make it more liquid,” Flores told OBG.

Facing this threat, the government and the BVL worked together to introduce a series of reforms. The authorities suspended a 5% capital gains tax on share transactions, made changes to allow brokers to act as market makers, introduced short selling and authorised a range of new products, including factoring and new real estate and property investment trusts.

The overall aim was to give investors more options so as to attract more funds and increase liquidity. The use of market makers is intended to allow trading in specific shares to take place over a longer time period each day, during which buy/sell prices will be available. Over the course of 2016 a number of companies signed agreements allowing market makers to trade their shares. Companies doing so in the first quarter of the year included Alicorp, Cementos Pacasmayo, Ferreycorp, Graña y Montero and Volcan. Between the second and fourth quarters of 2016 they were joined by Engie Energía and InRetail. In early 2017 insurance Rimac Seguros y Reaseguros also joined. Trades carried out by market makers in 2016 totalled PEN325m ($96.3m), and in the first two months of 2017 the value was PEN89m ($26.4m), or roughly 30% of the total turnover of those stocks, according to BVL figures.

In May 2016 MSCI decided to continue classifying one of the country’s three investable shares, Southern Copper, as a Peruvian equity – it had earlier been considering re-classifying it to its US index. Then, in June of the same year, MSCI confirmed BVL would retain its emerging market status.

Although the country still has just three stocks that meet the emerging market index criteria – apart from Southern Copper, the other two are financial group Credicorp and mining company Buenaventura – there are now a number of other stocks under consideration to join the list. Among those that may do so are Alicorp, InRetail, Volcan, Edelnor, Ferreycorp, Graña y Montero and Cementos Pacasmayo. After the MSCI decision was announced, Christian Laub, then-president of the BVL and CEO of Credicorp Capital, told local media, “This is just the beginning of a long process to which the Lima stock exchange has already committed in order to make the Peruvian exchange a regional benchmark.”

Strong Performance

In 2016 the BVL broke its three-year run of falling returns and got back on track with a strong growth trend. Indeed, the S&P/BVL Perú General’s 58.1% jump to 15,567 points in 2016 stood in sharp contrast to the 33.4% fall seen in 2015, according to WFE figures. The blue-chip index, S&P/BVL Perú Select, posted similarly strong growth in 2016, rising by 64% to reach 406.35 points. Overall domestic market capitalisation rose by 36.8% to $124bn.

The total number of companies listed on the BVL rose slightly over the period between December 2015 and December 2016, from 276 to 283, while average daily turnover rose to $18.3m, up from $14.2m the previous year. Héctor Collantes Luna, head of equity research at Credicorp Capital, told OBG that one of the big drivers of this improved performance was the domestic mining sector. “The key thing is that we had a recovery in mining, with an increase in production not seen in Peru since the 1970s. Coming at a time when perceptions of risk were quite high, this gave us a rate of return of nearly 60%,” Collantes told OBG. “So, Peru showed how volatile it can be, with everything good coming in 2016 after three bad years.”

Best Stocks

According to Alberto Arispe Bazan, general manager of Kallpa Securities brokerage, some of the best-performing stocks in 2016 were zinc mining companies such as Milpo and Volcan, the share prices of which rose by 189% and 65%, respectively. He attributed these increases to the fact that international zinc prices rose above expectations over the course of the year. Copper mining firm Cerro Verde also had a positive year, almost doubling its profits in 2016.

Another strong performer was Intercorp Financial Services, the holding company that controls Interbank, Peru’s fourth-largest bank by assets. Among the other above-average performers was sugar producer Casa Grande, which benefitted from rising sugar prices despite facing a long strike, and the consumer goods company Alicorp, which managed to boost profits despite sluggish retail market sales.

Arispe also told OBG that many infrastructure-related companies had a mixed 2016, as the hoped-for recovery in investment spending failed to materialise. He cited cement company Cementos Pacasmayo and capital goods producer Ferreycorp, whose profits came in below expectations. Graña y Montero, Peru’s largest construction company, also had a difficult year with sales and profit down as it suffered fallout from partnering with Odebrecht, the Brazilian civil engineering firm at the centre of corruption allegations. However, Graña y Montero announced a recovery plan for 2017, which includes the sale of some company assets. Graña y Montero shares fell sharply in early 2017 as allegations about its involvement in the Odebrecht affair continued to unsettle investors. By March 2017, however, a rally was beginning to take shape. The company overhauled its board of directors, making seven new appointments, and also said it was strengthening corporate governance mechanisms. In January 2017 it hired an external auditor to review its internal business processes.

At a March 2017 shareholders meeting, executives stated that the company had orders totalling $3.6bn in value, of which 11% were in the public sector and the remainder were private. The company’s exposure to financial losses related to the cancellation of the Gasoducto Sur Peruano gas pipeline project was being managed through an agreement with insurance company Chubb. The company was also reportedly making progress with banks to put the necessary credit lines in place to execute its full portfolio of projects.

Near Term

Collantes sees stock exchange growth continuing throughout 2017, although the driving factors will change. Having achieved a big boost in production in 2016, he expected the mining sector to be less important as an engine of growth in 2017. Instead, Collantes told OBG that infrastructure investment would likely play a big role, with investor interest shifting to construction companies, and perhaps to a lesser degree public utilities in the power generation and distribution segments. In his view, much will depend on whether the government is able to execute its ambitious investment programme. Collantes acknowledged that concerns over corruption might slow down the expected investment recovery.

Nonetheless, expectations have been broadly positive. Peru, like a number of other Latin American countries, is expected to pursue broadly business-friendly policies. Local currency gains have helped raise returns in US dollar terms and, importantly, in comparative terms, stocks in Peru and other Latin American markets are competitively priced. In March 2017 US shares, as measured by the S&P 500, were trading with priceto-earnings ratios of 25, while the Latin American average was just 14.3. The Peruvian average priceto-earnings ratio was more attractive still, at 12.3.

Another factor supporting strong BVL performance has been the gradual widening of the investment products on offer. These include the introduction of factoring and real estate investment trusts (see analysis). There has also been an increase in the number of exchange-traded funds (ETFs). In February 2017 the BVL reported that four new ETFs had been listed, bring the total number of locally quoted foreign securities to 102, including 71 ETFs and 31 foreign company shares.

By value, trades in foreign securities rose by 17% to $91m in 2016, of which 83% were trades in ETFs and 17% were trades in foreign shares. According to figures from the BVL, the most traded ETFs in 2016 were the SPDR S&P’s 500, the iShares MSCI All Peru Capped and the iShares MSCI EAFE. The top traded foreign shares on the BVL during 2016 were those of Citigroup, Apple and the Walt Disney Company.

Pension Funds

Peru’s private pension funds, known as pension fund associations (administradoras de fondos de pensiones, AFPs), have grown in importance as a source of funds for equity investments.

According to the industry group Asociación de AFP, there was a total of PEN137bn ($40.6bn) under administration by the end of December 2016, of which around 60% was invested within Peru in stock exchange-listed investment funds, term deposits, and fixed- and variable-income securities. The remaining 40% under administration is invested overseas.

There are three main investment funds: Fondo 1 (low risk), Fondo 2 (medium risk) and Fondo 3 (higher risk). According to the regulator, Superintendencia de Banca, Seguros y AFP, in 2016 these funds earned returns of 7.87%, 9.94% and 10.46%, respectively. The five-year average annual rates of return for these three funds, a period which included the stock exchange slump years of 2013-15, was 6.63%, 7.19% and 5.91%, respectively, meaning that the medium-risk funds actually performed better than the high-risk ones.

Diego Marrero, investment manager for local firm AFP Habitat, told local media that yields had improved in 2016 partly because of a year-end rally in global stock prices as the markets interpreted US President Donald Trump’s electoral victory as a signal of stronger economic growth to come in the US. Low global interest rates and narrowing country risk spreads also helped to boost government bond prices.

Taking A Stake

The BVL has been improving its links with other Latin American capital markets in recent years. Peru is one of four members of the Integrated Latin American Stock Market (Mercado Integrado Latinoamericano, MILA), a reciprocal agreement between the BVL and the stock exchanges of the other Pacific Alliance members – Chile, Colombia and Mexico – to move towards joint share listings and an interconnected trading platform. Although many of the technical aspects of the MILA agreement have been put in place, trades and initial public offerings conducted across the four bourses has been relatively slow to take off. Marco Antonio Zaldívar, president of the BVL, told local media that more needs to be done to integrate the MILA exchanges. He cited the example of the AFPs. Each of the four MILA countries have AFPs that invest in stocks, but the regulations governing how those investments are made are different. “We have a big objective and it is that every AFP should be able to invest in any of the four countries on the same conditions as if it were investing in its home country, and that it should not be forced to use different brokers in each country. To get there we need to harmonise our regulations.”

Better & Wider Market

There was, however, an important domestic milestone for the BVL achieved in early 2017. Bovespa, the main Brazilian stock exchange, bought an 8.59% stake in the Peruvian bourse. While not a controlling stake, the transaction made Bovespa – which has since rebranded as B3, following the takeover of a rival clearinghouse – the second-largest shareholder in BVL, as the bourse has an atomised ownership structure, with many brokers, banks and other institutions all holding small stakes. The purchase was in accordance with Bovespa’s policy objective of gaining a minority stake in all four stock exchanges in the Pacific Alliance trading group; it has already bought stakes in the Chilean, Colombian and Mexican bourses. Flores saw the transaction as highly positive for the BVL, since Bovespa would bring its expertise and help the Lima exchange widen its range of products; for example, the Brazilian exchange has experience in areas such as derivatives trading, which Peru is looking to develop.

A new regulatory framework for derivatives trading on the BVL has already been agreed, and operations could start in the coming months. Collantes made the additional point that Bovespa might help update and modernise the way the BVL processes and charges for trading transactions. This in turn could yield dividends for the Peruvian exchange, as a reduction in transaction costs could help the bourse attract greater investment and trading volumes.

Outlook

BVL share prices are widely expected to see solid growth in 2017, albeit at a somewhat slower pace than in 2016 as a result of less vigorous performance by mining stocks, as well as some doubts over the underlying strength of the economy as it rebalances towards non-primary sector-led growth. According to Flores, the general BVL index is on track to post a 15% increase in 2017 as a result of comparatively modest GDP growth on the one hand, and some uncertainty over how the Odebrecht corruption allegations might impact Peru’s planned infrastructure investments on the other. A notable one-off event also forms part of the forecast: the Peruvian government has offered a tax amnesty for citizens who have undeclared overseas assets, and who repatriate and declare them to the authorities in 2017.

As international cooperation between tax authorities has improved, similar amnesties have been offered by a number of Latin America countries, generating windfall gains in tax collection. A recent amnesty programme in Chile led to the repatriation of approximately $20bn worth of assets, of which about $1.5bn was paid over to the tax authorities.

What Peru might generate is difficult to predict, but Flores suggested a conservative estimate of around half the amount Chile collected. From a capital markets perspective, such an amnesty could see high-networth individuals invest some repatriated funds in the BVL. Brokers are already developing products and portfolios to meet that demand. For his part, Collantes shared a 15% growth forecast for the general index, in keeping with estimates that GDP growth would slow from 3.8% to 3.5% in 2017. However, additional downside risks could see this ease to 10%. He told OBG the government’s decision to increase the corporate tax rate to 29.5%, up from an expected 27% in 2017, could have a negative impact on equity investment. Collantes also acknowledged the potentially negative impact of corruption investigations on the execution of major infrastructure projects. However, he remained optimistic about the possibility of investment recovery, noting that following a raft of legislative changes in 2016 and 2017, Peru was putting in place a positive framework for infrastructure investment.