David Tuesta Chief Economist of Global Trends Unit Economic Research Department of BBVA FIAP

1. Asset prices in the economic cycle: a historic perspective David Tuesta Chief Economist of Global Trends Unit Economic Research Department of BBVA FIAP Warsaw, Poland 28 May, 2009 1

2. Contents 1 Basic aspects for pension fund development Demographics and economic structural variables 2 Size of Latin American pension funds 3 Current crisis impact on pension funds Stock Exchange Markets Developed vs. emerging countries Short and long-term profitabilities Ageing pension funds 4 Pension fund answers to the current financial crisis Regulations Portfolios allocation 5 Conclusion 2

3. Chile Peru Mexico Colombia Per capita GDP (constant US$) 2,954 7,370 2,317 7,537 Labor informality (% population not covered by social security) 24% 71% 41% 49% Labor legislation Protectionism (index) 24 61 38 27 Population of 65 years old and over 2005 5% 8% 6% 6% 2050 18% 22% 16% 21% Source: BBVA ERD Basic aspects for pension fund development 1 Demographics and economic structural variables are the main determinants of the current and future performance of pension schemes 3

4. Contents 1 Basic aspects for pension fund development Demographics and economic structural variables 2 Size of Latin American pension funds 3 Current crisis impact on pension funds Stock Exchange Markets Developed vs. emerging countries Short and long-term profitabilities Ageing pension funds 4 Pension fund answers to the current financial crisis Regulations Portfolios allocation 5 Conclusion 4

5. 2000 1995 2004 2008 Chile 42% 38% 59% 61% Colombia 5% 3% 9% 16% Mexico 3% -.- 5% 8% 5% 3% 10% 15% Peru Source: BBVA ERD 2 Size of Latin American pension funds Private Pension Funds (as a percentage of GDP) Since their creation, private pension funds in Latin America have grown continuously. The slope of the growth depends on the parameters of each pension scheme, financial market development, maturity of the system, as well as social and economic factors 5

6. 80% 61% 60% 40% 16% 15% 20% 8% 0% Source: BBVA ERD 2 Size of Latin American pension funds Private Pension Funds 2008 (as a percentage of GDP) Mexico Peru Colombia Chile Maturity of Private schemes (years of existence) 11 15 27 15 Some variables that are fundamental for the size of private funds Contribution rate * 6.5% 10% 11% 10% Historical real return 8% 10% 7% 10% Labor force participation in mandatory private funds 56% 22% 27% 69% * Not included social quota 6

7. Contents 1 Basic aspects for pension fund development Demographics and economic structural variables 2 Size of Latin American pension funds 3 Current crisis impact on pension funds Stock Exchange Markets Developed vs. emerging countries Short and long-term profitabilities Ageing pension funds 4 Pension fund answers to the current financial crisis Regulations Portfolios allocation 5 Conclusion 7

8. 3 Current crisis impact on pension funds The financial crisis not only affected developed countries but also Latin American markets Spread Embi (bp) Asset prices registered a deep fall and regional investment reflected a bigger increase in country risk

9. 3 Current crisis impact on pension funds Pension funds have suffered from the crisis… 2008 pension fund nominal returns in selected countries (%) Source: OECD

10. 100 Pension Plan Assets by Country, end 2007 80 Australia 60 United States Canada Ireland Sweden Japan 40 Chile UK Asset Allocation (% equities and mutual funds) Finland Switzerland Germany 20 Denmark France Netherlands South Africa 0 Mexico 20 40 60 80 100 120 140 160 Total Pension Assets (% GDP) Source: OCDE Global Pension Database 3 Current crisis impact on pension funds However, the pension funds of developed countries have been the most affected because of their high equity exposure The biggest Latin American pension funds, Mexico (persons) and Chile (assets), have been affected as well, but to a lesser degree

11. 3 Current crisis impact on pension funds Yields of Latin American countries have been affected but others have earned profits

12. Source: BBVA ERD *February 2009 Data Source: BBVA ERD *February 2009 Data Source: BBVA ERD *February 2009 Data Source: BBVA ERD *March 2009 Data 3 Current crisis impact on pension funds Colombia Chile Net yields of commissions have been affected but almost all have earned profits Peru Mexico

13. 3 Current crisis impact on pension funds The long-term yields have not been affected in Latin American Colombia Thus, regardless of the “minusvalías”, the value of the net yields of commissions still register an important long-term growth: 31.1% (2008) 33.5% (2007) 31.1% Source: BBVA ERD *February 2009 Data

14. 3 Current crisis impact on pension funds The long-term yields have not been affected in Latin American Chile Thus, regardless of the “minusvalías”, the value of the net yields of commissions still register an important long-term growth: 31.7% (2007) 24.3% (2008) 24.3% Source: BBVA ERD *February 2009 Data

15. 3 Current crisis impact on pension funds The long-term yields have not been affected in Latin American Peru Thus, regardless of the “minusvalías”, the value of the net yields of commissions still register an important long-term growth: 35.8% (2007) 27.6% (2008) 27.6% Source: BBVA ERD *February 2009 Data

16. 3 Current crisis impact on pension funds The long-term yields have not been affected in Latin American Mexico Thus, regardless of the “minusvalías”, the value of the net yields of commissions still register an important long-term growth: 55.7% (2008) 61.2% (2007) 55.7% Source: BBVA ERD *March 2009 Data

17. 3 Current crisis impact on pension funds Reformed Pension Systems in LATAM* Accumulated Real Yield** The most important thing has been the accumulated real yield in Latin America registered 7.9% in 2008. Source: BBVA ERD */ weight average by administrative assets of the systems profits in Colombia, Chile, Peru y Mexico **/ Figure out by accumulated net yield of commissions in each system.

18. 3 Current crisis impact on pension funds A multifund model linked to the affiliates’ life cycle has been an important element in strengthening the pension fund system * *People cannot be in more than one SB by law therefore the diagonal sum is 100%. The majority of affiliates have investment options with intermediate or conservative exposure to equities

19. 3 Current crisis impact on pension funds A multifund model linked to the affiliates’ life cycle has been an important element in strengthening the pension fund system Peru: Affiliates by age and type of fund* (%) Source: AFP Horizonte *Fund 1 is not included because 96% of affiliates are over 55 years old Older affiliates, with less time to recover possible losses, prefer the most conservative fund (Fund 2), while younger ones choose the higher risk fund (Fund 3)

20. 3 Current crisis impact on pension funds Some Problems in Latin American “multi-fondos” DC systems The default life-cycle model has step changes in asset allocation rather than gradual shifts Members can only choose one fund, defaults assign members to single fund; combination of two may be optimal Strategic asset allocations change with market conditions, no rebalancing  age-based default asset allocations moving around How you choose in the cumulative phase impacts management in the pay out phase Some Suggestions Each “multi-fondo” has a fixed equity-bond allocation and does regular rebalancing; details of strategic asset allocation left to AFPs, reviewed regularly Pension funds measure performance against market benchmark, not average industry return Regulator defines the default age-based investment glide path after a full calibration of model for a typical worker/s Allow international diversification Source: OECD

21. Contents 1 Basic aspects for pension fund development Demographics and economic structural variables 2 Size of Latin American pension funds 3 Current crisis impact on pension funds Stock Exchange Markets Developed vs. emerging countries Short and long-term profitabilities Ageing pension funds 4 Pension fund answers to the current financial crisis Regulations Portfolios allocation 5 Conclusion 21

22. Risk management supervision Design of elements with adequate information to mitigate risks Avoiding moral hazard: “fiduciary” responsibility and conflicts of interests Safeguarding the pensioners’ interests with adequate government policies Multifund: restrictions by age Portfolio diversification Giving precise information to pensioners Adequate measures for improving portfolio allocation Internal and external control of funds valuation Having minimum reserves Pension fund answers to the current financial crisis 4 Regulation and supervision schemes in Latin America have been extensive and precise

23. Pension funds answers over the current financial crisis 4 The reaction, facing the current financial crisis, has been quick Mexico Measures by financial authorities (SHCP, Bank of Mexico & Consar) Measures by Congress Measures by Industry • Oct-08 • Reduction of the long-term instruments supply • Re-Purchase instruments • Swaps of interest rate until $50 bn • Allow to temporary exceed the VAR levels authorized • Nov-08 • Authorization to Siefore for contracting credits in order to liquidate with future flows • Flows coordination (collection & liquidación de traspasos) • Temporary suspension of the automatic traspaso of Siefore by changes of the affiliates age • Dec-08 • SAR law reform • More rights to Consar for authorizing commissions • Quarterly instead of half Consar reports to the Congress • Send at least 3 balance to worker instead of 2 • Consar has faculties to establish measures that could protect worker resources in atypical circumstances in the financial markets • The Board of Governors of Consar can modify the investment regimen and reorganize the Siefore portfolios in extraordinary circumstances • Feb-09 • Afore agreement • 2009 giving follow up to SAR resources for investing in financial instruments and productive projects in Mexico • Considering infrastructure projects that could be compatible with the investment regimen • Continuing participating in housing financing, states and council projects

24. Pension funds answers over the current financial crisis 4 The reaction, facing the current financial crisis, has been quick • Creating a fourth fund with low risk. Investment of this new fund will be in fixed trade instruments (bonds, deposits and others). • Creating the Infrastructure Fund. The Pension Fund Administrators (AFP) willinvest in this new fund, improving the investors yield with long-term projects. • Modification approach of the AFPs commissions charge scheme, changing from a fixed commission to a mixed new type. In the fixed part will correspond a percentage of affiliate remuneration while the variable part will determine in function of pension fund profits. • Different approaches are addressed to protect workers affiliate to the pension private system and will be unemployed. Peru Chile • Flexibilization in the balance distribution process, affiliates who have their savings in two kinds of funds, will choose the new fund which received the new quotations. • Affiliates who have their savings just in one fund can choose a second type of fund to receive new quotations, without balance redistribution

25. Domestic Investment -Latam pension funds Fixed Income -Latam pension funds (Domestic investment share % in the system portfolio) (Fixed income share % in the system portfolio) 100 100 jul-08 90 90 dec-08 jul-08 80 80 dec-08 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Mexico Colombia Chile Peru Mexico Colombia Chile Peru Source: BBVA ERD Source: BBVA ERD Pension funds answers over the current financial crisis 4 Latin American pension funds search to protect their investment Allocating their portfolios in low volatility assets and with a lesser degree in changes risks

26. Contents 1 Basic aspects for pension fund development Demographics and economic structural variables 2 Size of Latin American pension funds 3 Current crisis impact on pension funds Stock Exchange Markets Developed vs. emerging countries Short and long-term profitabilities Ageing pension funds 4 Pension fund answers to the current financial crisis Regulations Portfolios allocation 5 Conclusion 26

27. Yield After a year Negative Yield Length (months) Recession 5 Conclusion None crises are the same and we do not know, how long is going to length the current one Great Depression (1929-1932) World War II (1937-1942) Post War II (1946-1949) Oil Crisis (1973-1974) Debt Crisis (1980-1982) Stock Exchange Crash (1987) Internet Bubble (2000-2001) 34 61 37 21 21 4 31 124% 59% 42% 38% 58% 23% 34% -86% -60% -30% -48% -27% -34% -49% (1) Current Crisis (2007- ?) 18.5 -46% ? Average 13 Crisis (exclusion the current crisis) 22 -39% 46% Source: ISI, Bloomberg, National Bureau of Economic Research, Haver Analytics (1) Accumulated Fall of S&P 500 Index

28. New Proposals 5 Conclusion Latin American pension fund systems are well-placed to face and recover from the current crisis Structural problems need to be resolved • Solidarity Pillar: Incentives in voluntary savings • Coverage: Mandatory and/or opt-out schemes for self-employed and non-contract workers • Implicit debt reduction • Equity diversification, taking into account considerations for mandatory pension funds • Disability and survivor benefits • Competition, fees and financial knowledge

29. 5 Conclusion Colombia Mexico Chile Peru BBVA promotes debate, research and the improvement of pension systems

30. Asset prices in the economic cycle: a historic perspective David Tuesta Chief Economist of Global Trends Unit Economic Research Department of BBVA FIAP Warsaw, Poland 28 May, 2009 30