Future of Alternatives 2025: Latin America’s Growing Appetite for International Private Equity Exposure

Political and macroeconomic challenges in the region are accelerating the flow of domestic capital offshore – and increasingly into the hands of private equity firms

In 2019, Latin America was rocked by a wave of civil unrest, including in the Chilean capital of Santiago. More than a million of the country’s 19 million inhabitants hit the streets in protest over inequality and a deeply entrenched lack of social mobility. Part of public anger was directed toward the private pension fund system, which has left some pensioners with smaller than expected payouts. 

The system was established in the 1980s under the Pinochet Government as Chile underwent an economic transformation, using a blueprint drawn from the Chicago School of Economics. Nationwide, all employees have been required to allocate at least 10% of earnings into one of several defined contribution schemes, known as AFPs. Similar systems were subsequently implemented across Mexico, Peru, and Colombia. Preqin data shows that total assets across all four of these markets are now approaching $500bn.

Regional Pension Funds Turn Outward for Alternatives Exposure
AFPs are leading the way on increasing exposure to international private equity. Large international investment allocations are nothing new in Latin America, given the lack of explicit liabilities to match and the relatively shallow domestic equity markets in which to invest. However, allocations to international private equity funds have started to accelerate in recent years as allocators pursue diversification and higher returns. 

With private equity allocations still in the low single digits, AFPs have considerable headroom to invest. Allocation limits to overseas investment are likely to increase as governments take further action to address the issue of pensions underfunding. And if the pension fund system is overhauled in Chile, the resulting disruption could trigger similar changes across the continent. 

Ongoing macroeconomic challenges may depress expected returns from Latin American assets and accelerate the shift to investments further afield. Indeed, COVID-19 has hit the region disproportionately hard: Chile, Peru, and Brazil have all recorded more cases per million than the US after 70 days from their respective outbreaks. While the region’s largest economies are expected to rebound next year from severe slowdowns in 2020, forecasts for GDP growth of between 2.2% in Mexico and 3.9% in Colombia for 2025 are modest by emerging market standards (Fig. 1).

In Brazil, Scarce Capital Stays Onshore
Notably, Brazil is proving the exception to the trend of increasing offshore investment. Although Brazil is the largest economy in Latin America, with sizable pension funds of its own, it also lacks domestic savings and the cost of borrowing is stubbornly high. In the past, this has tempted policy-makers to reduce interest rates to unsustainably low levels to promote shorter-term growth. Given the inevitable trade-off this presents, inflation and currency depreciation have remained strong in recent years. Brazilian pension funds allocate a negligible amount to offshore private equity funds due to regulatory restrictions. We consider it unlikely that the regulators will relax their conservative stance any time soon, preventing further offshore capital flows.

The combination of high currency volatility and high borrowing costs reduces the feasibility and attractiveness of Brazilian buyout funds, especially for international investors. A marked improvement in economic growth conditions, or strong return projections at an asset level, would be needed to help alleviate these concerns. However, the venture capital space is a bright spot, which is likely to garner more attention in the coming years. Preqin Pro tracks 126 fund managers currently investing in Brazilian venture capital.

Global Investors See Opportunities in Latin America 
The private equity market in Latin America has grown over the past decade. Data from Preqin Pro shows the annual number of private equity transactions in Latin America increased from 133 in 2010 to a high of 400 in 2019. The aggregate value of these deals has climbed more slowly, from $8.8bn to $10bn in 2019. Private equity fundraising, however, has been on a declining trend, sliding from a high of $11bn in 2011 to $2.8bn in 2019, which should benefit those still in the market with capital to deploy.

Although the majority of investors we surveyed for Future of Alternatives 2025 do not invest in Latin America, 12% of respondents that do not currently invest in the region plan to start by 2025. What’s more, while only 9% of fund managers believe South America is presenting the best investment opportunities at present, almost a quarter (24%) see some of the best opportunities in 2025 (Fig. 2). 

While Latin America is not a market for the faint hearted, there will be opportunities for investors and fund managers that are prepared to dig deep.

Download a data pack containing all the charts in our regional articles for Future of Alternatives 2025. For more predictions and projections from Preqin on the future of the alternatives industry, visit our Future of Alternatives 2025 Content Hub.