The portfolio of the AFPs has been diversified considerably since the start of the system. While most of the funds were placed in bank deposits in the beginning, already about a quarter of total assets were invested in shares by the end of 1996. This represented about 1 percent of the market capitalization of the Lima Stock Exchange (Salomon Brothers 1996). In Chile, pension fund investment in equities was still zero 5 years after the start of the AFP system, but they have now reached 30% of assets and about 10% of the Santiago market capitalization.

Investment of pension funds in foreign securities is theoretically subject to a limit of 5 percent of assets. However, the real restriction appears to lie in the fact that a list of foreign investments needs to be permitted and risk-rated before AFPs can invest and that not many permitted foreign instruments have been identified yet. Further, as observed in other countries, pension fund managers seem to have a home bias in their investment strategies for reasons such as the costs of hiring staff to analyze overseas markets, opposition of affiliates to foreign investment and the assumption that the downside risk of overseas investment outweighs the potential benefits of higher returns (Downs 1996). It is expected that the SAFP will authorize AFP investments in Peruvian Brady Bonds in 1997 and that the AFPs will take advantage of this investment opportunity.

About 77 percent of the portfolio is denominated in soles and 23 percent is in US dollars. Bank deposits are generally of less than 90 days term. Of these, 25 percent are dollar denominated, 20 percent sole-denominated but indexed, and 55 percent sole-denominated but non-indexed. Fixedincome investments account for about 70 percent of all assets.

The AFPs portfolio shows a very high exposure to the banking sector which at the end of 1996 accounted for 39 percent of all investments (bonds, deposits and shares). The AFP regulations do not limit the overall exposure of AFPs to the banking sector. If investments in other financial institutions, such as leasing companies and consumer credit institutions, are also taken into account, the share of financial sector investments reaches 46 percent. Particularly the large share of subordinated bank bonds in the AFP portfolio could cause problems. These bonds are treated as capital in the Peruvian banking regulations and are admitted for the AFPs reserving purposes as _encaje_ (Downs 1996). Since in terms of risk, the subordinated bonds are closer to equity than bonds, this could mean that the reserves might turn out to be insufficient, particularly as AFPs are no longer required to maintain fluctuation reserves. Moreover, the subordinated bonds, though quasi-equity instruments, are likely to be remunerated like debt instruments.

Investments in the industrial sector make up 20 percent of the portfolio; the mining sector accounts for 7.8 percent and public services for 18.6 percent. The single largest investment of the private pension system is in corporate bonds and shares of the telephone company, Telefonica del Peru, amounting to 14.3 percent of all assets.

The differences between the portfolios of the 5 AFPs are small. The reason for the similar investment choices may be due to several factors, including the direct and indirect regulatory restrictions and the limited availability of investment instruments. The Peruvian govemment has not issued long term debt since the late 1980s and there is a limited supply of long-term government bonds on the market. Trading on the Lima Stock Exchange is very limited; it averages less than US$ 20 million a day and only about half of the stocks are actively traded. In 1996, the equity trading volume corresponded to about 6 percent of GDP (IFC 1997). There are 60 bonds of 21 corporate issuers listed with a total face value of about US$ 340 million with two large companies, Telefonica del Peru and Consorcio de Alimentos Fabril Pacifico, accounting for 30 and 26 percent, respectively (Downs 1996) 18