The Nineteenth Dubrovnik Economic Conference
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1 The Nineteenth Dubrovnik Economic Conference Organized by the Croatian National Bank Sergio Schmukler Capital Market Development in Emerging Economies: Challenges Ahead Hotel "Grand Villa Argentina", Dubrovnik June 12-14, 2013 Draft version Please do not quote
2 Capital Market Development in Emerging Economies: Challenges Ahead Sergio Schmukler World Bank 19th Dubrovnik Economic Conference June 12- June 14, 2013 Dubrovnik, Croatia
3 Introduction Two important questions: 1. What are some of the challenges in financial development (FD)? 2. What is the role of institutional investors in this process and in these challenges?
4 Introduction Only selected challenges in FD (not stability) Developing country/emerging market (EM) perspective Capital markets and institutional investors (not specifically banks) Bird s eye view wide range of issues Scattered evidence from different sources Go through the evidence first Discuss policy issues later
5 Introduction Over the last two decades, big push to develop financial markets From a bank-based model to a more complete model Savings through capital markets with dispersed ownership Widespread access to finance to all firms U.S. model As a consequence of all the reforms and efforts, markets have indeed developed and integrated Also become significantly more complex and interconnected
6 Introduction Large institutional investors expected to play a crucial role Retirement (in addition to voluntary) savings Channeled through asset managers, particularly mutual funds and pension funds Invest in many companies and countries Informed investors, able to make independent decisions Invest long term Take advantage of arbitrage opportunities Absorb shocks, particularly equity investors Help stabilize and develop the financial system
7 Introduction Despite many new developments, many challenges remain Large heterogeneity across regions and countries No convergence yet advanced economies developed even more Many of the improvements centered in certain areas, and countries Many shortcomings in several important EMs Bank credit stagnated in various countries Firm financing from banks decreased in relative terms Bond markets expanded, but with limitations In banks and bonds, public sector still captures significant share Equity markets still small, illiquid, and concentrated in large firms Institutional investors sophisticated and large in several countries, but with much more limited role than previously thought
8 Introduction Far away from model of dispersed ownership and participation Supply versus demand effects Constraints not on lack of available funds: domestic & foreign savers Many assets available for investment not purchased by institutional investors or foreigners, which hold large resources Institutional investors seem to shy away from risk Incentives to banks to move first into relatively easy markets (consumer, leasing, services), after big corporations left to capital markets Incentives to asset managers and the overall functioning of financial systems does not contribute to expectations
9 Introduction Many firms not becoming public or not accessing markets Capital markets service only few firms, with increasing size and concentration domestically and abroad Substantial financing through retained earnings and banks Regulations do not seem to be the main obstacle Several challenges ahead Growing savings Role of financial intermediaries Need for more risk taking paired with stability Spillovers to all firms Need to catch up Complexities and interconnectedness
10 Outline Financial development: banks, bond markets, stock markets Institutional investors
11 Outline Financial development: banks, bond and stock markets Institutional investors
12 % of GDP Size of Financial Systems Has Increased Size of Domestic Financial System Banks Bonds Equities 350% 300% 250% 89% 200% 150% 100% 50% 0% 66% 77% 36% 56% 13% 8% 83% 84% 95% 66% 36% 128% 31% 13% 17% 43% 51% 50% 69% 92% 97% 104% 123% 32% 20% 36% 62% 35% 60% 42% 28% 20% 33% 39% 44% 54% 52% 80% 85% 59% 105% Asia (5) China Eastern Europe (2) G7 (5) India LAC7 (6) Oth. Adv. Economies (4) Source: IFS, BIS, and WDI. Eastern Europe: Poland, Russia, Turkey, Hungary, Czech Republic, Croatia, Lithuania
13 % of Total Domestic Market Relative Size: Bonds, Equity Have Gained Prominence Domestically Across Regions Size of Domestic Financial System 100% 90% 80% 39% 32% 11% 7% Banks Bonds Equities 16% 29% 25% 27% 28% 36% 40% 32% 36% 29% 34% 70% 21% 60% 50% 18% 27% 16% 35% 35% 33% 23% 22% 23% 27% 28% 24% 40% 82% 30% 20% 42% 41% 56% 63% 40% 38% 39% 41% 38% 44% 37% 43% 42% 10% 0% Asia (5) China Eastern Europe (2) G7 (5) India LAC7 (6) Oth. Adv. Economies (4) Source: IFS, BIS, and WDI
14 % of GDP Banks: Uneven Evolution Private Bank Claims 140% % 117% 100% 93% 107% 100% 80% 60% 76% 71% 73% 65% 82% 58% 72% 40% 20% 44% 31% 23% 34% 24% 24% 40% 29% 29% 30% 0% Asia (5) China Eastern Europe (3) G7 (5) India LAC7 (6) Oth. Adv. Economies (6) Numbers in parentheses next to region names represent the number of countries included in the graphs. Source: IMF s IFS
15 % of Total Credit Banks: Relative Decline in Corporate Lending Credit Composition Commercial Mortgage Personal 100% 90% 22% 19% 17% 17% 18% 18% 11% 10% 10% 14% 24% 26% 9% 9% 8% 80% 70% 60% 50% 37% 51% 58% 34% 40% 49% 43% 47% 47% 19% 14% 14% 43% 43% 42% 40% 30% 20% 10% 40% 31% 25% 49% 41% 34% 45% 42% 43% 66% 62% 60% 48% 48% 50% 0% China Eastern Europe (2) G7 (2) LAC7 (6) Oth. Adv. Economies (3) Source: Local sources
16 % of Total Bank Assets Banks: Foreigners Significant and Growing Relative Size of Foreign Banks % 50% 46% 43% 49% 40% 30% 20% 20% 25% % 30% 20% 22% 17% 16% 10% 0% Asia (4) China Eastern Europe (7) G7 (4) LAC7 (7) Oth. Adv. Economies (4) Source: Van Horen (2008)
17 % of GDP Bond Markets Have Expanded, But Public Sector Still Large and Growing Composition of Bond Markets, % of GDP Private Bonds Public Bonds 120% 100% 80% 65% 60% 52% 40% 32% 31% 24% 20% 0% 20% 16% 24% 4% 4% 23% 13% 14% 40% 2% 4% 41% 48% 33% 19% 15% 1% 2% 5% 23% 10% 30% 40% Asia (5) China Eastern Europe (2) G7 (7) India LAC7 (7) Oth. Adv. Economies (5) Source: BIS
18 % Total Bond Market Capitalization Bond Market Turnover Not on the Rise Bond Value Trading as % of Total Bond Market Capitalization 200% % 178% 160% 140% 120% 110% 100% 80% 80% 84% 80% 60% 56% 58% 59% 57% 40% 20% 30% 24% 18% 35% 23% 39% 39% 31% 21% 15% 12% 12% 0% Asia (3) China Eastern Europe (3) G7 (4) India LAC7 (4) Oth. Adv. Economies (4) Note: Trading data includes domestic private, domestic public and foreign bonds traded in local stock exchanges. Source: World Federation of Exchanges (WFE)
19 % of GDP Private Bond Issuance Is Small 5.0% Amount of New Issues % 4.5% 4.0% 3.5% 3.4% 3.0% 2.5% 2.0% 1.6% 1.7% 1.5% 1.0% 1.2% 0.8% 1.1% 1.1% 0.5% 0.0% Asia (5) G7 (7) LAC7 (7) Oth. Adv. Economies (7) Source: SDC
20 Number of Firms Private Bonds: Few (and Fewer) Firms Use Markets Average Number of Firms Issuing Bonds Asia (5) G7 (7) LAC7 (7) Oth. Adv. Economies (7) Source: SDC
21 % of Total Amount Raised Private Bonds: Few Issues Capture Significant Share 100% Concentration in Private Bond Markets Amount Raised by Top 5 Issues % 80% 70% 69% 60% 60% 55% 54% 59% 50% 40% 43% 30% 27% 20% 20% 10% 0% Asia (5) G7 (7) LAC7 (6) Oth. Adv. Economies (6) Note: Concentration is defined as the top-5 issues as a percentage of the total amount raised by firms in domestic bond markets. Numbers in the base of the bars represent the average number of yearly issues. Source: SDC
22 Equity Market Capitalization 100% Market Capitalization as % of GDP 90% 89% 85% 80% 77% 70% 60% 66% 66% 69% 62% 54% 50% 42% 40% 30% 31% 32% 28% 20% 10% 13% 13% 0% Asia (5) China Eastern Europe (2) G7 (7) India LAC7 (7) Other Advanced Economies (7) Source: SDC
23 Turnover Ratio Equity Trading: A Different Picture than Mkt. Cap. Trading Activity Turnover Ratio 200% 180% 189% % 140% 120% 100% 80% 60% 73% 85% 124% 47% 61% 75% 128% 62% 102% 40% 20% 25% 17% 0% Asia (5) China Eastern Europe (7) G7 (7) LAC7 (7) Oth. Adv. Economies (7) Note: Turnover ratio is defined as the total value traded per year in domestic markets over total market capitalization. Source: SDC
24 % of Total Value Traded Partly Explained by Trading Abroad Value Traded Abroad to Total Value Traded % 60% 54% 61% 58% 50% 40% 30% 27% 23% 20% 10% 13% 11% 12% 10% 12% 13% 8% 5% 4% 5% 3% 3% 12% 19% 16% 15% 0% Asia (1) China Eastern Europe (1) G7 (5) India LAC7 (4) Oth. Adv. Economies (5) Source: Bank of New York and Bloomberg
25 % of Total Value Traded Trading Is Somewhat Concentrated 80% Concentration in Domestic Equity Markets Share of Value Traded by Top 5 Companies % 70% 60% 63% 58% 60% 57% 50% 40% 36% 39% 39% 30% 20% 21% 20% 10% 0% Asia (5) China Eastern Europe (5) India LAC7 (6) Source: EMDB
26 % of GDP Breadth of Equity Markets: Issuance Activity Small Equity Markets Issuance Activity 1.8% 1.6% 1.6% % 1.4% 1.4% 1.2% 1.1% 1.0% 1.0% 0.9% 0.8% 0.8% 0.7% 0.7% 0.7% 0.6% 0.4% 0.2% 0.2% 0.3% 0.3% 0.2% 0.0% Asia (5) China Eastern Europe (7) G7 (7) India LAC7 (6) Oth. Adv. Economies Source: SDC
27 Number of Listed Firms Equity Markets: Few Firms List Number of Listed Firms 6, ,207 5,000 4,441 4,000 3,000 2,000 1, , Asia (5) China Eastern Europe (7) 2,322 2, G7 (7) India LAC7 (7) Oth. Adv. Economies (7) Source: WDI
28 Number of Listed Firms Equity Markets: Even Fewer Firms Raise Capital Average Number of Firms Raising Capital Asia (5) China Eastern Europe (7) G7 (7) India LAC7 (6) Oth. Adv. Economies (7) Source: SDC
29 % of Total Amount Raised Equity Markets: Also with Significant Concentration 100% 90% 80% Concentration in Domestic Equity Markets Share of Amount Raised by Top 5 Issues 92% % 77% 85% 70% 60% 50% 40% 61% 62% 47% 50% 39% 45% 54% 68% 63% 30% 29% 20% 10% 0% Asia (5) China Eastern Europe (7) G7 (7) India LAC7 (6) Oth. Adv. Economies (7) Source: SDC
30 Issuing Firms Larger than Non-issuers, Grow More Firm Size Distribution by Issuance Activity 2003 Total Assets of Non-Issuing Companies 2003 Total Assets of Issuing Companies China Equity Issues 2010 Total Assets of Non-Issuing Companies 2010 Total Assets of Issuing Companies Log of Total Assets A firm is considered as issuing if it had at least one equity issue between 2003 and 2010.
31 Issuing Firms Larger than Non-issuers, Grow More Firm Size Distribution by Issuance Activity 2003 Total Assets of Non-Issuing Companies 2003 Total Assets of Issuing Companies India Equity Issues 2010 Total Assets of Non-Issuing Companies 2010 Total Assets of Issuing Companies Log of Total Assets A firm is considered as issuing if it had at least one equity issue between 2003 and 2010.
32 For Bond Issuers, the Results Are Starker Firm Size Distribution by Issuance Activity 2003 Total Assets of Non-Issuing Companies 2003 Total Assets of Issuing Companies China Bond Issues 2010 Total Assets of Non-Issuing Companies 2010 Total Assets of Issuing Companies Log of Total Assets A firm is considered as issuing if it had at least one equity issue between 2003 and 2010.
33 More So in India Firm Size Distribution by Issuance Activity 2003 Total Assets of Non-Issuing Companies 2003 Total Assets of Issuing Companies India Bond Issues 2010 Total Assets of Non-Issuing Companies 2010 Total Assets of Issuing Companies Log of Total Assets A firm is considered as issuing if it had at least one equity issue between 2003 and 2010.
34 Outline Financial development: banks, bond and stock markets Institutional investors
35 Organization of the Evidence Hard to have a unified framework to analyze the evidence Findings from different papers using data from Chile, the U.S., and the world financial centers Findings on different aspects of institutional investor behavior, in particular their asset allocation Emphasis on regulated investors (mutual funds & pension funds) Food for thought Role of institutional investors Incentives at the manager and investor level Public policy
36 Evidence on Institutional Investors Overview Size of pension funds and mutual funds Asset allocation Pension funds in Chile Trading and herding Long-term investors? International evidence Diversification Pro-cyclicality Benchmark effect
37 Evidence on Institutional Investors Overview Size of pension funds and mutual funds Asset allocation Pension funds in Chile Trading and herding Long-term investors? International evidence Diversification Pro-cyclicality Benchmark effect
38 % of GDP Pension Funds Gaining Ground Pension Fund Assets 40% % 34% 33% 30% 30% 26% 25% 20% 19% 15% 16% 15% 15% 10% 5% 0% 0% 0% 2% 5% Asia (4) China Eastern Europe (7) 5% 6% G7 (7) India LAC7 (7) Oth. Adv. Economies (6) Source: AIOS
39 % of GDP Mutual Funds Growing Too Mutual Fund Assets 40% 35% % 36.7% 30% 25% 23.7% 20% 17.1% 19% 15% 10% 12% 7.9% 7.4% 7% 10.0% 5% 2% 2% 4.3% 4% 0% Asia (4) China Eastern Europe (7) G7 (7) India LAC7 (7) Oth. Adv. Economies (6) Source: ICI
40 % of Total Portfolio However, Portfolios Are Concentrated in Deposits and Public Bonds Composition of Pension Fund Investments in Latin America Govt. Securities Fin. Inst. Sec/Deposits Private Bonds Foreign Securities Equities Mutual Funds Other Investments 100% 90% 80% 70% 60% 2% 11% 6% 9% 21% 2% 3% 14% 12% 8% 50% 16% 40% 30% 20% 51% 45% 10% 0% Source: OECD, ABRAPP, AIOSFP, FIAP, and local sources
41 % of Total However, Portfolios Are Concentrated in Deposits and Public Bonds Pension Fund Holdings Cash and Deposits Public Bonds Private Bonds Loans Equity Mutual Funds Others 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 10% 7% 5% 1% 16% 37% 24% 2% 10% 34% 10% 40% 18% 25% 20% 6% 11% 16% 4% 22% 32% 5% 3% 2% 10% 19% 20% 16% 1% 1% 19% 20% Asia (2) Eastern Europe (4) G7 (5) LAC7 (5) Other Advanced Economies (6) 26% 7% Source: OECD Latest available information. Data for most countries are from 2009.
42 % of Total Assets Mutual Fund Assets Also Concentrated in Bonds and MM Instruments Mutual Funds - Portfolio Holdings 100% 90% 80% 70% 60% Deposit Certificates Private Bonds Equity Brazil Government Bonds Fixed Inc. Sec. Backed by Gov. Debt Others 4% 5% 11% 2% 17% 5% 15% 4% 50% 40% 30% 20% 73% 48% 10% 0% 6% 11% Source: IMF s IFS, FGV-Rio, Conasev, Superfinanciera, Andimia, and Banxico
43 % of Total Assets Mutual Fund Assets Also Concentrated in Bonds and MM Instruments Mutual Funds - Portfolio Holdings Chile Deposits Private Bonds Domestic Equity Foreign Equity Public Bonds 100% 90% 80% 70% 6% 14% 8% 2% 4% 9% 17% 13% 60% 50% 40% 30% 63% 63% 20% 10% 0% Source: IMF s IFS, FGV-Rio, Conasev, Superfinanciera, Andimia, and Banxico
44 Evidence on Institutional Investors Overview Size of pension funds and mutual funds Asset allocation Pension funds in Chile Trading and herding Long-term investors? International evidence Diversification Pro-cyclicality Benchmark effect
45 Share of portfolio Along with MFs, They Tend to Invest Short Term 100% 90% 80% 70% Maturity Structure of Chilean Domestic Mutual Funds and PFAs vs. Insurance Companies 60% 50% 40% 30% 20% 10% 0% Chilean PFAs Chilean Domestic Mutual Funds Chilean Insurance Companies Years to maturity Avg. Maturity (1) Chilean Insurance Companies (2) Chilean Domestic Mutual Funds 3.88 (3) Chilean PFAs 3.16 Note: This figure compares the maturity structure of Chilean insurance companies to that of Chilean domestic mutual funds and PFAs. Only medium- and long-term bond mutual funds are taken into account. Source: Opazo, Raddatz, Schmukler (2013)
46 Outline Overview Size of pension funds and mutual funds Asset allocation Pension funds in Chile Trading and herding Long-term investors? International evidence Diversification Pro-cyclicality Benchmark effect
47 Similar Number of Holdings Across Fund Types and Relatively Constant over Time Foreign Funds Median Number of Holdings by Fund Type Emerging Market Funds World Funds Regional Funds World Funds Ex-US Assets Source: Didier, Rigobon, and Schmukler (2013) Specialized Funds
48 Similar Number of Holdings Across Fund Types and Relatively Constant over Time Asia Funds Median Number of Holdings by Fund Type Country Funds Europe Funds Latin America Funds Source: Didier, Rigobon, and Schmukler (2013)
49 Having Managers in Common Increases Entropy Entropy Measures across All Holdings Entropy No Common Manager At least 1 Common Manager More than 3 Common Managers Holdings in Developing Countries Only Source: Didier, Rigobon, and Schmukler (2013)
50 in % in % in % in % in % Equity Mutual Funds Appear Truly to Active Follow their Benchmarks to a Great Extent Global Emerging Funds and MSCI 1 EM Index Explicit Indexing Israel s Upgrade from the Emerging Market Index to Developed Market Index Global Funds and MSCI World Index Explicit Indexing Truly Active Mean Weight Israel Benchmark Weight (MSCI EM) Truly Active
51 Concluding Remarks: Bottom Line In terms of financial development, substantially different and better than before, even when insurmountable Deeper systems, in domestic and international fronts More saving and more resources available in the economy Less crowding out by governments, but governments still large According to some measures, consumers appear to be better served Financial system more complex, somewhat more diversified Not that much bank-based Bonds and equity play bigger role, corporate bonds emerging Institutional investors much more prominent Nature of financing is also changing
52 Concluding Remarks: Bottom Line But no finance for all! Financial development through capital markets not spread to all firms Constraints not on the supply side of funds Constraints not on the availability of investable assets Constraints likely not on specific regulatory issues These get much attention at country level, but this is a cross-country issue Financial intermediation process more difficult than thought First expands to areas relatively easy to finance Incentives might play crucial role for more risk taking Might not yield socially optimal outcome Financial intermediaries brain of the economy, but works differently than expected
53 Concluding Remarks: Bottom Line Not clear how to proceed in many areas Institutional investors are emblematic Similarly with banks, capital markets, and financial integration Nor what to expect of capital market financing Plus lack of obvious paradigm at international level Collapse of role models: no roadmap after the crisis E.g. what to make of securitization and mortgage financing? Eventually, need to catch up, grow, and take risk without undermining stability: strong trade-off Macro-prudential policies might not help Hard to distinguish spurious boom from leapfrog Especially for lagging areas and countries
54 Some of the General Policy Challenges Generate healthy competition among financial intermediaries without perverse incentives Promote market discipline through standardization Foster benchmarking without boosting short-termism, herding, and volatility Foster long-term risk while being able to monitor managers Contrarian behavior and long-term arbitrage opportunities without generating backlash due to negative outcomes Take advantage of useful international diversification
55 Going Long and Riskier Asset managers, including pension funds Large chunk of domestic savings intermediated by asset managers Spend significant part of fees in marketing perhaps could be diverted to asset management? Avoid risk taking, forgoing good long-term returns for investors and risk capital for corporations But at the same time shield them from volatility Herd to be close to the pack Difficult task to change investment model Without excessive risk taking Without alienating investors Generating proper incentives
56 Problems Are Widespread U.S. and developed countries institutional investors too present some odd investment patterns Invest in few stocks Do not share information within companies Are pro-cyclical even when investing in equities and even when shocks have already hit them Are subject to shocks from investors Follow benchmarks, which adds to pro-cyclicality Organizational problems seem to pervade the industry No clear alternative model
57 Thank you!
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