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in Emerging Economies: Challenges Ahead Hotel "Grand Villa Argentina", Dubrovnik June 12-14, 2013 Draft version Please do not quote
Capital Market Development in Emerging Economies: Challenges Ahead Sergio Schmukler World Bank 19th Dubrovnik Economic Conference June 12- June 14, 2013 Dubrovnik, Croatia
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?
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
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
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
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
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
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
Outline Financial development: banks, bond markets, stock markets Institutional investors
Outline Financial development: banks, bond and stock markets Institutional investors
1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 % 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
1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 % 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
% of GDP Banks: Uneven Evolution Private Bank Claims 140% 1980-1989 1990-1999 2000-2009 120% 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
2000-03 2004-07 2008-09 2000-03 2004-07 2008-09 2000-03 2004-07 2008-09 2000-03 2004-07 2008-09 2000-03 2004-07 2008-09 % 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
% of Total Bank Assets Banks: Foreigners Significant and Growing Relative Size of Foreign Banks 1995-1999 2000-2008 60% 50% 46% 43% 49% 40% 30% 20% 20% 25% 0.1485 12% 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)
1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 1990-9 2000-9 % 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
% Total Bond Market Capitalization Bond Market Turnover Not on the Rise Bond Value Trading as % of Total Bond Market Capitalization 200% 2000-2003 2004-2007 2008-2009 180% 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)
% of GDP Private Bond Issuance Is Small 5.0% Amount of New Issues 1991-1999 2000-2008 4.7% 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
Number of Firms Private Bonds: Few (and Fewer) Firms Use Markets Average Number of Firms Issuing Bonds 500 450 400 369 1990-1999 2000-2008 462 350 300 250 200 150 100 50 0 21 30 19 20 24 9 Asia (5) G7 (7) LAC7 (7) Oth. Adv. Economies (7) Source: SDC
% of Total Amount Raised Private Bonds: Few Issues Capture Significant Share 100% Concentration in Private Bond Markets Amount Raised by Top 5 Issues 1991-1999 2000-2008 90% 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
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) 1990-1999 2000-2009 Source: SDC
Turnover Ratio Equity Trading: A Different Picture than Mkt. Cap. Trading Activity Turnover Ratio 200% 180% 189% 1990-1999 2000-2009 160% 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
% of Total Value Traded Partly Explained by Trading Abroad Value Traded Abroad to Total Value Traded 2000-2003 2004-2007 2008-2009 70% 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
% of Total Value Traded Trading Is Somewhat Concentrated 80% Concentration in Domestic Equity Markets Share of Value Traded by Top 5 Companies 1990-1999 2000-2009 73% 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
% of GDP Breadth of Equity Markets: Issuance Activity Small Equity Markets Issuance Activity 1.8% 1.6% 1.6% 1991-1999 2000-2008 1.4% 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
Number of Listed Firms Equity Markets: Few Firms List Number of Listed Firms 6,000 1990-1999 2000-2009 5,207 5,000 4,441 4,000 3,000 2,000 1,000 0 715 425 441 1,382 225 167 Asia (5) China Eastern Europe (7) 2,322 2,072 224 175 385 828 G7 (7) India LAC7 (7) Oth. Adv. Economies (7) Source: WDI
Number of Listed Firms Equity Markets: Even Fewer Firms Raise Capital Average Number of Firms Raising Capital 600 1991-1999 2000-2008 531 500 400 300 258 296 200 100 0 38 101 86 91 Asia (5) China Eastern Europe (7) 2 5 86 18 5 58 118 G7 (7) India LAC7 (6) Oth. Adv. Economies (7) Source: SDC
% 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% 1991-1999 2000-2008 85% 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
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.
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.
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.
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.
Outline Financial development: banks, bond and stock markets Institutional investors
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
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
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
% of GDP Pension Funds Gaining Ground Pension Fund Assets 40% 2000-2004 2005-2009 35% 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
% of GDP Mutual Funds Growing Too Mutual Fund Assets 40% 35% 2000-2004 2005-2009 34% 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
% 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% 1999-2004 2005-2008 Source: OECD, ABRAPP, AIOSFP, FIAP, and local sources
% 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.
% 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% 2003-4 2005-9 Source: IMF s IFS, FGV-Rio, Conasev, Superfinanciera, Andimia, and Banxico
% 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% 2000-4 2005-9 Source: IMF s IFS, FGV-Rio, Conasev, Superfinanciera, Andimia, and Banxico
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
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 1 2 3 4 5 6 7 8 9 10 Years to maturity Avg. Maturity (1) Chilean Insurance Companies 10.32 (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)
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
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Similar Number of Holdings Across Fund Types and Relatively Constant over Time 160 140 120 100 80 Foreign Funds Median Number of Holdings by Fund Type Emerging Market Funds 60 40 20 World Funds Regional Funds World Funds Ex-US Assets 0 160 Source: Didier, Rigobon, and Schmukler (2013) Specialized Funds
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Similar Number of Holdings Across Fund Types and Relatively Constant over Time 160 140 120 100 80 60 40 20 0 Asia Funds Median Number of Holdings by Fund Type Country Funds Europe Funds Latin America Funds Source: Didier, Rigobon, and Schmukler (2013)
Having Managers in Common Increases Entropy Entropy Measures across All Holdings 1.00 0.90 0.80 0.70 Entropy No Common Manager At least 1 Common Manager More than 3 Common Managers 0.60 0.50 0.40 0.30 0.20 0.10 0.00 Holdings in Developing Countries Only 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Didier, Rigobon, and Schmukler (2013)
in % in % in % in % in % Equity Mutual Funds Appear Truly to Active Follow their Benchmarks to a Great Extent 5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 4.5 4 3.5 3 2.5 2 1.5 Global Emerging Funds and MSCI 1 EM Index Explicit Indexing 0.5 0 Israel s Upgrade from the Emerging Market Index to Developed Market Index 0.45 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0 Global Funds and MSCI World Index Explicit Indexing 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 Truly Active Mean Weight Israel 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Benchmark Weight (MSCI EM) Truly Active
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
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
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
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
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
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
Thank you!