Big Fish in Small Ponds: Pensions and Capital Market Development in Latin America

The exponential growth of Latin American pension funds’ assets under management has not contributed to the substantial development of local capital markets, as widely expected. This puzzle is not easily solved by studies that point to pension funds' concentration of investment in public bonds and tendency to “buy-and-hold” securities, adding little liquidity to secondary markets. These important considerations ignore a new and prominent trend toward investment diversification among these funds. Rather than a linear outcome of pension funds’ growth, investment diversification and the consequent development of local financial markets are contingent on macroeconomic parameters and industry-specific incentives. These are systematically identified and analyzed in the paper to reveal seldom-explored financial dynamics on which the economic sustainability and continued political legitimacy of funded old-age pension schemes lie. The conclusion is that the relationship between financial development and the evolution of the private pension industry in Latin America has been conditional yet still more dynamic than often depicted in the literature.