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Beating The Bear Market

Puerto Rico’s Retail Brokerage Business Is Booming, Thanks To A Local Mutual Fund Market That Tops $5.6 Billion And Is Expected To Exceed $12 Billion Within Five Years


April 17, 2003
Copyright © 2003 CARIBBEAN BUSINESS. All Rights Reserved.

Brokerage firms are winning clients over with local mutual funds, partnerships with banks

A compelling investment

Puerto Rico’s investment brokerage sector has managed to beat a more than three-year bear market.

While many of their stateside counterparts have been suffering under the weight of capital-market nosedives and corporate scandals, the island’s leading brokerage firms have spent the past few years seeking to make the most of their forte in fixed-income securities as well as their expanded reach through greater integration with the banking sector.

Figures from the Office of the Commissioner of Financial Institutions (OCFI) show that since the bubble burst on Wall Street in March 2000, an additional $2.5 billion in local mutual funds have been sold--exclusively to Puerto Rico residents--by the island’s investment brokerage sector.

As recently as September 2000, the total value of investments in the 16 local funds that were registered with the OCFI between 1994 and 2000 was still below $2 billion. In 2001 and 2002, however, nearly a dozen additional local funds went to market and, by December 2002, the total value of local mutual funds stood at over $5.6 billion.

"This market has surpassed the $5 billion mark during the eight years since its inception [as a result of the Investment Company Act of Puerto Rico] in 1994," observed UBS PaineWebber Senior Vice President Leslie Highley. "I think the market has the capacity to surpass the $12 billion mark over the next five years."

"Last year we had the biggest percentage rate of growth of assets under management within the entire, worldwide UBS PaineWebber operation," said UBS PaineWebber of Puerto Rico President Miguel Ferrer. The local mutual fund market has been the main driver of that growth.

Good place to go

Since their inception, the local mutual funds--which typically invest at least 67% of their assets in fixed-income securities issued by Puerto Rico institutions, with the remaining 33% mostly in U.S. securities--have been consistently delivering average annual dividend rates of between 6% and 7%.

What helps make these returns especially attractive is that most fund dividends are structured to be tax-exempt, while a few are structured at a flat 10% tax rate. Another attraction is that the shares aren’t subject to Puerto Rico estate and gift taxes or to U.S. inheritance taxes. UBS PaineWebber, Santander Securities, Popular Securities, Smith Barney and Oriental have been the principal issuers of local mutual funds. Other local brokerage firms also participate by selling their clients funds originated by sector leaders. Still other firms that are seeking to scale greater heights in the market, such as BBVA Capital Markets and R-G Investments, have announced plans to start offering funds of their own in the near future.

Jose Rafael Fernandez, Oriental Financial Group executive vice president, pointed out that local investors have been flocking to the funds--as well as to other fixed-income investment options such as variable annuities--and staying away from volatile stateside equity investments.

"People’s conservative reaction is justified," said Popular Securities Managing Director Juan Guerrero, commenting on both local and stateside cases where investors who jumped headfirst into the equities markets in the late 1990s came out burned and shell-shocked after the bubble burst and a long bear market stretch began to take hold.

"The risk aversion even moved fixed-income products to become more conservative," said UBS PaineWebber’s Leslie Highley. The firm’s latest local mutual fund, which closed $108 million in January alone, invests 95% of its assets in securities with the highest credit quality (AAA). "That’s a reflection of how we adjust to the market," said Highley.

The leaders of investment firms interviewed by CARIBBEAN BUSINESS agreed that the bursting of the bubble also took the wind out of the sails of many local solo investors who--with the advent of online trading--had opted to make investment decisions entirely on their own.

As a result, firms closely identified with the promotion of self-directed online trading haven’t been doing as well in Puerto Rico as they had hoped. Other stateside firms--with investment models not tailored to the fixed-income orientation of the local market--have also had setbacks in their island operations.

"We’ve been emphasizing the fact that our asset allocation models aren’t canned, but tailor-made to the Puerto Rico market," said Santander Securities President and Carlos Garcia. Popular Securities’ Guerrero and UBS PaineWebber’s Miguel Ferrer also highlighted the value of a customized approach to the market.

Financial modernization

Several of the island’s leading brokerage firms are also benefiting from their accelerated integration into the structure of major bank-branch networks.

Congressional passage in 1999 of the Financial Services Modernization Act (also known as Gramm Leach Bliley) facilitated affiliations between banks, securities, and insurance firms. This has given brokerage firms a golden opportunity to work with banks in order to offer clients a full range of financial services.

UBS PaineWebber, the leader of Puerto Rico’s brokerage sector, has entered into partnerships with FirstBank and Doral Bank, giving its brokers the ability to work with clients in bank branches all across Puerto Rico, as well as in FirstBank branches in the U.S. Virgin Islands.

Santander’s Garcia said the integration of Santander’s banking and brokerage services is moving forward at a fast pace. "I think we have an edge, since our bank’s president [Jose Ramon Gonzalez] was formerly the president of Santander Securities and our team has a shared vision for integrating banking and brokerage products," he said.

"Probably the biggest impact of financial modernization for Popular will actually be in providing coverage for our uninsured or underinsured clients," said Popular’s Guerrero. "Insurance is a natural offshoot of financial planning, and because of the confidence that banks have earned from their clients, we’re in a better position to help our clients fill their insurance gaps."

At the same time, Guerrero pointed out that Popular Securities is keen on seeing its share of the island’s brokerage business (it has an estimated 11% share at present) grow to equal its market share in terms of island bank deposits (where it is the market leader, at over 35%).

"We’ve only seen the tip of the iceberg in this regard," said Oriental’s Jose Rafael Fernandez, who noted that Oriental Chairman, President & CEO Jose Enrique Fernandez’s goal has long been to offer clients the full spectrum of financial services. "That’s why Oriental was the first bank with a brokerage operation in 1993, and why we’ve had an insurance company since 1995."

Oriental began by focusing on bringing in clients to take their very first step in financial planning--through opening retirement accounts such as IRAs--and has steadily expanded its relationships with clients to include insurance, annuities, mutual funds, and other bank products.

Westernbank has a strategic alliance with California-based Financial Network Investment Corp. to provide a variety of brokerage and investment products to its clients, while BBVA has increasingly integrated BBVA Capital Markets into its network.

Last year R&G Financial created a new subsidiary, R-G Investments, to serve R-G Premier Bank and R-G Mortgage clients. Citibank is also a major player in the field, with the services of Smith Barney fully integrated into several of its biggest branches.

Trends going forward

Smith Barney Senior Vice President Rafael Colon Ascar warned that Puerto Rico investors should be careful about investing too heavily in strictly local products. "One shouldn’t depend on only one economy," he said. "Local financial stocks have been doing great during the refinancing boom, for example, but that’s not going to continue for much longer."

"You should never put all your eggs in one basket," agreed Jose Rafael Fernandez. "There is some overweighting on the fixed-income side, and I expect investors will start shifting back a little for a more balanced approach."

All of those interviewed agreed that in terms of providing services to more clients, there is room for much more growth. Though not all the firms interviewed revealed how many clients they have, based on those that did it is estimated that as many as 35,000 local households may have accounts with local brokerage firms. "That number should be much closer to 70,000," said one when asked about the potential for growth during the remainder of this decade.

Smith Barney’s Colon Ascar said that many people who could benefit from the higher rates of returns and tax advantages offered by local mutual funds, for example, still have their money parked in their banks’ savings and certificate of deposit accounts.

"We still have a lot more selling to do," he said, referring to the need to educate people about making the best use of their liquid capital.

"In Puerto Rico, we’re seeing the shift take place," said UBS PaineWebber’s Ferrer. "This is where the market is growing in the financial sector, when people make that shift from being only deposit holders to being investors." Ferrer pointed out that stateside, assets held by brokerage firms exceed those held by commercial banks, and that Puerto Rico is moving in that direction.

To date, however, most local brokerage firms have done little advertising to get new clients. "Referrals are still the way almost all of our new clients come in," said Colon Ascar. That may be starting to change, though. UBS PaineWebber, for example, has been noticeably increasing its advertising, and Santander Securities isn’t far behind.

"Last month we launched a major campaign entitled ‘Women with Vision,’ directed at young and middle-aged professional women," said Santander’s Garcia. "This is a segment that we identified as needing a different approach." Popular Securities is also doing some limited advertising, while Citibank’s reformulated "Citigold" marketing campaign also features cross-selling of conventional banking, investment and insurance products.

Previously focused primarily on serving high-net-worth individuals, the island’s brokerage firms are increasingly looking to serve households with annual incomes ranging from $50,000 to $100,000. "As a rule of thumb, we think that if someone has that income level or has $20,000 in liquid capital, he or she is in a position to benefit," said Garcia.

Securities Industry Association aims to reel in more business

The Securities Industry Association of Puerto Rico (SIA), an organization that unites the island’s leading brokerage firms, is seeking to stimulate the growth of local capital markets through a series of measures before the Legislative Assembly.

"The reason I decided to assume the presidency of the SIA is that there are several important bills in the Legislature that are pending and that up until now here hasn’t been enough effort to get them enacted," said UBS PaineWebber of Puerto Rico President Miguel Ferrer, who assumed the presidency of the SIA last month.

"Because of global events, we are at a historic juncture, where Puerto Rico has enormous opportunities to emerge as a major regional financial center," said Ferrer. The veteran industry leader pointed out that in the wake of 9/11, the wave of corporate scandals, and the subsequent enactment of new regulatory regimes such as the Patriot Act and Sarbanes-Oxley, other regional financial centers outside the U.S. are under pressure and are less secure than they were before.

As Ferrer sees it, tens of billions of dollars could move into Puerto Rico if the island seizes the opportunity to enhance and promote its position as a part of the U.S. within this new regulatory regime, while also being able to offer unique incentives as a result of its fiscal autonomy.

Ferrer said that during his presidency of the SIA this year, he intends the organization to work to ensure that necessary action occurs, particularly in helping to achieve the approval and enactment of pending legislative measures, such as an already filed bill that would reduce the tax rate applicable to local corporate debt to 10%.

"This would have a big impact because it would reduce the cost of money for Puerto Rico corporations; Treasury would receive money that it doesn’t receive at present; and it would give us a new instrument for making investments in Puerto Rico companies," said Ferrer, who noted that until now, local corporate debt issues have only been placed stateside.

Another pending bill the SIA hopes to see passed this year would reduce from 20% to 10% the tax that applies to distributions of island-based retirement plans that have a designated portion of their investments in Puerto Rico. Ferrer said that island residents currently have $17 billion in retirement funds invested stateside and that this amount grows by about $1 billion a year.

"That’s a pool of money that’s bigger than the Section 936 funds in their heyday," Ferrer said. "This incentive would start gradually bringing some of that money back here and would create jobs for more third-party administrators, money managers, and brokers in Puerto Rico."

A third bill that the SIA is promoting has generated opposition from the Treasury Department, which is concerned it would have a negative fiscal impact. Known as the Real Estate Investment Trusts Law, the bill would create a new vehicle for financing commercial real-estate projects, such as shopping centers. Ferrer said that stateside firms are able to take advantage of an effective federal real-estate investment trusts law, but current Puerto Rico law is inadequate.

The SIA initiative that has perhaps created the biggest stir to date is the proposal to attract top Puerto Rican and other stars in the entertainment and sports world to establish themselves and incorporate their businesses in Puerto Rico. "If we do this right, we can offer them something better than Miami can, in terms of the impact on their pocketbooks," said Ferrer. The legislative proposal, which is expected to be announced as early as next week, would offer tax benefits for the non-Puerto Rico income generated by artists and athletes who establish residency and businesses in Puerto Rico.

Another legislative project Ferrer hopes will materialize this year entails a new venture capital law. The SIA president said a new law is necessary because the current one hasn’t been effective in generating sufficient local venture capital activity.

This Caribbean Business article appears courtesy of Casiano Communications.
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