Not Much of a Safe Haven

The Mexican stock market seems to have a split personality these days. On the one hand it is a runaway regional performer. The exchange’s main index increased 10 % in dollar terms this year through August, while the Dow Jones Industrial Average fell 10%.

On the other hand, however, the stock market is as much of a regional dud as most of its Latin American compatriots when it comes to liquidity. The exchange’s market capitalization has shrunk 30% since its peak in 1994. Trading volume has dropped 20% this year alone, to $125 million a day. Liquidity is declining, the number of listed companies has fallen to 180 from more than 200 in 1994. The exchange has seen only a handful of initial public offerings since 1997. The last company to list was América Móvil, a mobile phone company, which went public in February.

The exchange’s woes are becoming ever more apparent at a time when global and dedicated regional investors are viewing Mexican stocks as a safe haven for resources they have pulled out of Argentina and Brazil. Shares of companies such as Telmex, América Móvil, Televisa, Banorte, Walmex, Elektra and Cemex have all appreciated due to growing investor interest in Mexico this year. However, like many Latin American bolsas, the Mexican Stock Exchange cannot attract enough companies willing list their shares. Furthermore, the market suffers from a lack of retail and institutional investors.

The larger Mexican companies list their shares locally and on the major international exchanges, principally the New York Stock Exchange in ADR form. Telmex was the first Mexican company to list its ADRs on the NYSE in 1991 and there are now 26 Mexican companies with ADR programs in place. Trading shifts usually almost overnight to New York once a company lists on the NYSE.

Eugenio Clariond, chief executive officer of the steel manufacturer Grupo Imsa, points out how closely the Mexican market tracks that of the US. Some months ago he looked at his trading screen on a Monday and saw very little trading. It was Martin Luther King Day. “What does that have to do with the Mexican bolsa?” Clariond asks indignantly. “When the US market shuts down, the Mexican market shuts down.”

The local equity market is a source of growing irritation for Imsa, which went public in Mexico and New York in 1996. “People have lost interest in the domestic market,” says Clariond. “Eighty percent of all the trades in the bolsa are in four stocks. Apart from Telmex and some others, there is no market.”

Mexico’s equity culture is skin deep. Few companies consider the stock market a reliable source of financing. They have traditionally financed growth with retained earnings, bank debt or bonds, rather than by selling equity to outside investors. This is for a variety of reasons, principally an unwillingness to share power with investors or comply with financial disclosure requirements for public companies. A proposed capital gains tax could add yet another disincentive for companies to access the equity market.

Some of the country’s biggest and best corporate names are being bought by foreigners and their stocks removed from the Mexican stock market. Banamex-Accival, the parent company of the country’s second bank Banamex, delisted in early August after its $12.5 billion purchase by Citigroup. However, Citigroup applied for a Mexican listing shortly after the takeover.

Local investor interest in equities is weak. The country has a population of 100 million, but only 140,000 people have brokerage accounts. However, the government is to blame as well. Current regulations prevent the country’s pension funds, which were privatized in 1997, from investing more than 10% of their asset in equities, although the national retirement fund commission is considering easing this rule.

The upshot is that the exchange is suffering simultaneously from inadequate supply of fresh stocks and weak demand. Without further reform, the Mexican equity market does not have a particularly bright future.

In April, the Mexican Stock Exchange appointed Guillermo Prieto as president, replacing Manuel Robleda who had led the exchange for eight years. Robleda is credited with improving the exchange’s efficiency and use of technology but was not particularly aggressive in addressing its fundamental problems.

Prieto, a boyish-looking 39-year old who previously headed Consar, the pension fund regulator, says, “Our main challenge is to develop and increase the domestic base of investors and to attract more issuers.”

Prieto knows he has an enormous task ahead and that his success in reviving the stock market depends largely on factors that are beyond his control, such as returning the country to growth and continued low interest rates. “There are a lot of ‘ifs’,” says Prieto, and not all of them depend on the exchange. But we have to regain the image that the exchange is a place where you can invest for the long-run and make the market more accessible to investors and issuers.”

Prieto wants to convince the government to use the capital markets for future privatization of state companies, instead of selling them to strategic investors. The government held an initial public offering a year ago for the first time when it privatized Asur, an airport operating company. It raised $335.8 million in a simultaneous offering in Mexico City and New York in September 2000. Management is vested in an international consortium holding 15% of the company, with the remainder held by the public. No single investor can hold more than 10% of Asur’s shares. This US-style corporate structure is unique in Mexico, where companies continue to be dominated by family owners.

The government also plans to partially privatize the country’s electricity industry. That idea gained some momentum in August when the head of Mexico’s electrical workers’ union, which had steadfastly opposed privatization, proposed that workers’ pensions be invested in increasing the generating capacity of the national electricity system.

Outdated regulations prevent Mexico’s pension fund management firms from investing in equities. They have assets under management of $47.36 billion, equivalent to 8.1% of GDP. In developed countries, pension and mutual funds are vital investors in the equity market. In Mexico, pension funds, which are known as Afores, are so tightly regulated that even their investment in corporate debt is limited since rules specify the percentage of assets that must be invested in risk-free government securities.

Prieto says the pension system’s actuarial structure means fund managers must be allowed to invest more in stocks. Interest rates are heading down, making it harder for fund managers to earn returns needed to pay pensions in the future. Some 85% of Afore account holders are under 45 years of age.

“This means that it’s going to take an average of 25 to 30 years for many of these people to reach retirement and much longer for people who are entering the labor force now,” says Prieto. “We think a small percentage, 10 to 15% of the portfolio, could be an excellent way to increase the value of pensions.”

Renato Grandmont, Latin American equity strategist at Deutsche Bank, says the stock exchange must be able to attract more companies if it is to attract sufficient amounts of capital. “If you have a strong equity culture, you will have a lower cost of financing through equity issuances,” says Grandmont. “If you don’t have an equity culture, you are never going to grow the market because there is no money there to invest.”

Prieto says that the exchange will try to convince medium-sized companies to list. They are not familiar with the process of issuing stock or find it too complex. “This is where we have to make a lot of contact and communication with potential issuers,” he says. “That does not mean these companies are going to come for the first time and issue stocks. But we have to make companies acquainted with the market.” He says they need information and help in becoming much more transparent with their information. They also need help in adapting to the new corporate governance laws.

In June, Mexico passed a raft of laws aimed at improving the rights of minority shareholders (see “Equal Rights for All,” page 18) and boosting the transparency of the financial markets. “I think the approval of the law is a very good indication that policymakers understand that there is a problem there and they want to see it resolved,” says Grandmont. “Allowing pension funds to invest in equities would be a another possible positive step in that direction.”