Joo Sang-Chul, NPS Research Institute
Korean institutions are being driven to raise overseas exposures to counter size limitations and low yields in their domestic market, creating opportunities for global fund houses, a forum in Seoul heard yesterday.
Panellists also explained the criteria they use for selecting managers, during a discussion on international investment portfolios at AsianInvestor’s eighth annual Korea Institutional Investment Forum.
Explaining the rationale behind boosting overseas investment, Park Min-Ho, chief investment officer of the $11 billion Teachers’ Pension, said Korea was lagging the global average in terms of GDP growth, yet 90% of the firm’s investment portfolio was domestically focused.
“A ratio of 9-1 is too much of an imbalance,” he noted. “We want more of a diversification effect. Also, in the medium-to-long term, we believe inflation will become a problem [in Korea]. Therefore, we want to hedge that [inflation risk] by increasing exposure to overseas markets.”
Joo Sang-Chul, research fellow in the investment policy division of the NPS Research Institute, also pointed to the diversification effect, particularly given the National Pension Service’s assets of over $400 billion.
He said NPS’ portion of the domestic stock market in market cap terms stood at 2.7% in 2005, but had risen to 6.5% by the end of April, driven chiefly by growth in reserves. “The effect NPS is facing is the difficulty of being a big fish in a small pond. Therefore we need to expand internationally.”
Cho Sung-Sik, managing director in the variable insurance management office at Mirae Asset Life Insurance, observed that prior to 2008, the US government had focused on core strengths of IT and finance, while putting manufacturing out to the rest of the world.
However, that did not end well, with both sectors becoming overly bloated, he noted. The US government has since reversed that decision. But Cho said Korea’s economy has not prospered since. “We need more security in the future. That is why it is necessary to diversify assets globally,” he said.
The domestic low-yield environment has been a catalyst for raising international exposure. “Asian institutions have experienced massive growth in AUM, while the capacity of the local markets is limited,” said Priscilla Luk, director of index research and design at S&P Dow Jones Indices. “They need to diversify and they need a higher return to maintain their payout ratio.”
Asked which assets he favoured, Park said that while traditional investments had delivered an average growth rate of just 2% since 2008, alternatives returns had been in the 10% range.
“Whether this continues remains to be seen, but we will increase our portion of alternatives in the overseas market to 20%,” he said, without giving a timeframe. “I believe valuations will be an issue for advanced markets. Therefore we have to monitor the performance of emerging markets.”
Teachers’ Pension hired three consultants last year with a view to increasing its portion of overseas assets, added Park, using the MSCI World Index as its benchmark on the equity side. “Our goal is to beat the benchmark. We would also like to have more categorisation by style, to be more specialised."
Almost 80% of NPS’ overseas equity investing is outsourced to external managers, with an active approach to gain excess return. The remaining 20% is handled in-house and typically passively managed, said Joo. Its international equity benchmark is the MSCI AC (ex-Korea) Index. The fund has 90% of its overseas stock investment in developed markets, and just 10% in emerging markets.
Meanwhile, Mirae Asset is implementing a 5% reduction in exposure to global fixed income this year. “The decision to rebalance to equity was taken at a company level,” said Park, noting that the firm would also be reducing its allocation to high-yield bonds, which had performed well last year.
Turning to the question of active versus passive investment, Park said that while an active approach is Mirae Life's chief focus, since overhauling its strategy the firm had put more into passive strategies. He described its approach as semi-passive. “We have looked into regional ETFs as part of an enhanced indexing strategy."
Luk pointed out that most institutions have core active allocation, with Asian asset owners having a lower allocation to passive than US peers.
Given the drive to invest internationally by Korean institutions, she said their lack of experience in this often meant taking a passive approach at first. She pointed, too, to the rise of alternative beta indices as a way to enhance returns actively in a cheaper way, highlighting such moves by Japan’s Government Pension Investment Fund and Taiwanese pension funds.
Part of the appeal, she argued, was the ability to back-test performance and break down investment characteristics in a systematic way to analyse why funds might have outperformed or underperformed.
Asked about the criteria for selecting a manager, Cho said Mirae Asset looked for professionalism and specialism in a particular style. “Sometimes we see managers with a big name but little expertise, and a very fashionable portfolio. Sometimes we see teams formed very quickly.
“We do not want that. We want to get the selection of managers aligned with our strategy. We want to see a good track record within a strategy and good teamwork.”
Park of Teachers' Pension pointed to a three-stage process: firstly an assessment of whether a manager’s benchmark is appropriate to judge whether it is performing through skill or luck.
“We also look to see what kind of people are employed, because we need people with expertise who can support performance. Thirdly, it is to check whether an appropriate process and investment philosophy is in place.”
For overseas investment he stressed the importance of communication, adding: “But we cannot overlook the issue of cost.”