/ New Investment Regime for Chilean Target Date Pension Funds Expands (Somewhat) Investment Opportunities

The final Investment Regime preserves the hybrid benchmark model but introduces greater flexibility in key parameters affecting active management, alternative assets and aggregate underlying fees. Reference indices are still pending, but are due to be published shortly.

Felipe Cousiño
Partner

Francisca Donoso
Senior Associate

The Chilean Pension Regulator (Superintendencia de Pensiones or the “SP”) has published the Investment Regime that will govern the ten (10) life cycle pension funds (also known as generational funds or target date funds (“TDFs”)) beginning on April 1, 2027. The core framework presented during the consultation process remains unchanged: each AFP will define its own strategic asset allocation within regulatory ranges, and that allocation will serve as the benchmark against which performance is measured. However, the final text departs from the consultation draft in several respects that materially affect the investment universe and economic conditions of the new system.

Overall, the final regime is somewhat more flexible than the version submitted for public consultation. It expands limits for growth assets and alternative assets, reduces the rigidity of the performance measurement and incentive framework, and increases concentration capacity with alternative asset managers and banking counterparties. At the same time, it introduces more detailed controls regarding benchmark portfolio construction and duration management. It also adds flexibility to create master pension fund structures (fondos de pensiones matrices).

However, the Investment Regime imposes quarterly reductions on exposure to alternative assets as well as on aggregate underlying fee limits, which might create an operational challenge to invest in private equity and private debt.

Moreover, the indices (índices de referencia) to be used to build the benchmarks have yet to be determined by the regulator, but are expected to be published shortly.

Certain key features of the final regime are the following:

1. More Room for Growth Assets and Alternative Assets, but quarterly reductions might impair investment.

The consultation draft established an initial limit of 90% for growth assets and an aggregate limit of 20% for alternative assets (which included private equity, private debt, and certain domestic alternative assets). The final version increases the limit to  95% and 25%, respectively (except private equity which stays at 20%), for the earliest life-cycle stages, while maintaining in most cases a quarterly  reduction throughout the glide path. This quarterly reduction beginning at the early life cycle stage TDFs has been criticized given it might cause AFPs to reduce every quarter their exposure to alternative assets, such as private equity, from the outset. This may prove to be contractually and operationally challenging and unrealistic.

This negative effect is compounded by the quarterly reductions in the aggregate underlying fee limits throughout the life cycle of each TDF.

On the other hand, certain domestic alternatives count as defensive assets, thus leaving more room for the growth assets bucket.

Thus, while the intention of the regulator is to promote building portfolios with greater exposure to equities, high yield, emerging markets fixed income, private equity, private debt, infrastructure, real estate and other private markets investments, it is unclear whether the desired result may be achieved.

2. Private Equity Maintains a Presence in Later Life-Cycle Stages

Under the consultation draft, the specific limit applicable to private equity declined to 0% beginning at Stage 7 (61 to 65 year olds) and remained at that level through the “Consolidation Fund” (i.e. Stage 10, the last stage of a TDF, which is for those over 75 years old). The final version instead raises the limit to a 3% l from Stage 7 through Stage 10.

This change is particularly relevant for funds with long investment periods and vehicles with limited liquidity windows, as it somehow reduces the risk that the glide path could require a complete structural exit from the asset class. Thus, the amendment expands the potential market for private equity sponsors and co-investment platforms for the later life-cycle stage funds.

3. The Performance Measurement and Incentive Framework Becomes Less Restrictive

The final regime substantially widens the structural bands by reference to their benchmarks, above which AFPs will receive performance fees or below which they will have to reimburse the TDFs. Indeed, the bands are widened from an annual range of 60 to 90 basis points under the proposal to 240 to 290 basis points in the final text, while establishing a uniform maximum annual tracking error of 3%, compared to the proposed range of 0.60% to 1.10%, as a condition to trigger the performance fee.

In practical terms, AFPs will have greater flexibility to deviate from their benchmark portfolios and face a less demanding threshold for eligibility to receive performance-based compensation. At the same time, the wider bands require a greater level of excess return before compensation becomes payable. Taken together, these changes reduce pressure toward narrow index-tracking strategies and provide greater flexibility for active management.

4. Greater Concentration Capacity with Alternative Asset Managers

The limit applicable to investments in alternative vehicles managed by a single manager, including unfunded commitments and co-investments with that manager, increases from 2% to 3% of the relevant TDF.

This amendment allows more meaningful allocations to global managers and facilitate larger institutional relationships.

5. A More Flexible Transition Period

For the period between April 1, 2028, and March 31, 2031, the consultation draft contemplated an annual structural band of 300 basis points and a maximum annual Tracking Error of 3.5%.

The final regime increases those parameters to 400 basis points and 4.5%, respectively.

This provides AFPs with a more flexible adaptation period to migrate from the current multifund system, implement new benchmark portfolios and adjust risk management and performance attribution processes.

6. Greater Capacity with Banks and Liquidity Providers

The consultation draft established a permanent limit of 4% per bank or financial institution, together with transitional limits of 6.5% during the first 24 months and 5% during months 25 through 36.

The final regime directly establishes a 6.5% limit and eliminates the gradual step-down mechanism.

This change increases capacity for deposits, bank debt, equity investments and OTC derivatives exposure with a single institution and is particularly relevant for custodian banks, derivatives counterparties and liquidity managers.

7. Investment Grade Syndicated Loans Receive an Exemption

The consultation draft required every syndicated loan to include a CMF-supervised bank, unrelated to the AFP, holding at least 5% of the total principal amount.

The final version exempts syndicated loans carrying an investment grade rating from that requirement.

This amendment facilitates structures led by private debt funds or institutional lenders where the credit risk has already been independently rated and creates a more efficient avenue for financing projects, concessions and infrastructure assets.

8. Greater Flexibility for Indirect Real Estate Investments

For structures implemented through Chile registered closed-end funds investing in Chilean real estate companies, the consultation draft required those companies to allocate at least 90% of their assets to residential real estate intended for leasing arrangements.

The final version reduces that threshold to 80%.

This amendment allows a greater proportion of complementary or temporary assets within the underlying real estate company and facilitates the structuring of local investment vehicles. It provides additional flexibility for fund managers, developers and real estate sponsors.

9. Higher Aggregate Underlying Fee Limits, but quarterly reductions from the outset create disincentives

The consultation draft established annual aggregate underlying fee limits ranging from 0.56% for the earliest life-cycle stages to 0.14% for the Consolidation Fund.

The final regime increases those limits to 0.61% and 0.19%, respectively, albeit with quarterly reductions throughout the life cycle.

This move to quarterly reductions beginning at the earliest stage TDFs has been criticized, as mentioned in 1 above..

10. Master Pension Funds

Another interesting feature of the Investment Regime is that each AFP may be authorized to form one or more master pension funds (fondos de pensiones matrices) through which  assets of one or more of the TDFs may be invested. This master fund structure is no longer limited to specific asset classes and may serve as a mechanism to overcome challenges of transfers of assets between TDFs as they move along their relevant life-cycle.

These master pension funds are also seen as being helpful aggregators creating economies of scale  for new entrants wanting to compete with incumbent AFPs..

11. Exceptional Circumstances.

The SP is granted authority, following consultation with the Consejo Técnico de Inversiones and the Ministry of Finance, to temporarily suspend or modify parameters, limits, bands, benchmark portfolios or glide paths in response to unforeseen circumstances.

This is intended to  strengthen the regulator’s ability to respond to extraordinary market events.

This Investment Regime will become effective on April 1, 2027.

If you require additional information, please do not hesitate to contact our Capital Markets team.