Bank of Korea emboldened in diversification drive

Choo Heung-Sik, head of the central bank’s reserve management group.
Bank of Korea emboldened in diversification drive

The Bank of Korea manages almost $330 billion in foreign reserves and cannot invest in domestic assets originated by resident institutions, such as dollar bonds issued by Korea Development Bank.

BoK diversifies its portfolio in terms of currency and asset class, investing not only in government bonds, but also in supranationals and agencies, mortgages, corporate debt and a small portion of global equities.

Choo Heung-Sik joined the organisation in reserve management. He also worked at the World Bank in Washington, DC from 2008-2009.

Q Can you outline the scope of Bank of Korea’s investments?

A We are diversified in terms of currency like any other central bank. Overall our dollar portion is around 60%, which is the global average as disclosed by the International Monetary Fund.

In terms of management, 17% of our reserves is managed by external asset managers, particularly for equities, corporate fixed income, mortgages and our China QFII investments. Our biggest external manager is Korea Investment Corporation (KIC), which manages about 7% of our total foreign reserves. This is different from China Investment Corporation (CIC), which owns the money and all the profit-loss belongs to them.

We own the money, but KIC manages it on our behalf as an external manager under the guidance of the guideline provided by us and for that we pay a management fee.

Other than KIC, we have about 30 global asset managers; last year we hired two domestic asset managers for our renminbi investments. That was a first for us. Also, Bank of Korea is unique in that we have an internal management capability in mortgage-backed securities.

Q What is the central bank’s allocation to different asset classes?

A As of the end of 2012, equities accounted for almost 6%. The remaining 94% was in cash and fixed income, with a small amount in time deposits. The portion of government bonds is about 38%, and this includes the US, Germany, the UK, France and even Australia. We do not disclose country by country.

Q Can you offer more details on your international investments and thinking around equities and fixed income, including corporate debt?

A Over the last 10 years, our investment proportion of government bonds has been reduced by about half, so we are investing 38% of our foreign-currency-denominated assets in them as at the end of 2012.

Instead, we have started to invest in non-government bonds for the purpose of portfolio diversification. Agency, corporate and asset-backed bonds including mortgage-backed securities compose 22%, 13% and 17% of our assets, respectively.

For further diversification, we expanded our investment universe to include equities in 2007. The return on equities is more volatile than for bonds, but we think equities have the effect of enhancing our risk-return profile because of their negative correlation with bonds.

Q What additional international investments are you looking to make in 2013?

A In terms of diversification, we have enough as of now. We have already started to invest in equities, emerging markets and onshore renminbi bond and equity markets. The more important task for us is composition of the asset classes, especially in this extremely low-yielding environment for fixed income. Asset allocation is a concern for us and we have a team dedicated to that.

Q Do you use consultants?

A No. Personally I think hiring consultants could be a big help to us, but as a central bank it is not easy to hire consultants, especially if you can get similar resources from your chosen partners – asset managers and investment banks.

We are in a position to have a deep discussion with the Bank for International Settlements (BIS) and the World Bank. From time to time we have a peer review with them on our asset management, and these relationships act as a kind of a compromise for us not having any consultant service from the private sector.

Q When did you get your QFII quota and how have you allocated it?

A BoK received $300 million in January last year. We hired six external fund managers, including Chinese, global and Korean [individuals]. They are managing China A-shares under our QFII licence.

Q What investment opportunities do you see in emerging markets?

A Currency diversification. If you have a long-term perspective for 10 years and beyond, emerging market currencies have become an important part of reserve management. So it is natural for us to move in that direction very gradually.

In terms of asset class diversification, emerging markets can also provide us with a higher return relative to embedded risks compared with our current asset-class composition. Looking ahead, emerging markets are going to be more important.

Q Do you buy emerging market bonds?

A Yes. Whether we will put more money to work in emerging markets is not a this-year or a next-year question; it is a five-year question.

Q When you invest overseas, what size of investment do you normally make?

A When I was a young junior it was $10 million, but these days it is far more than that.

Q What about alternative investments and direct investing. Is that on the horizon?

A As of now, alternatives are not in our investment universe because of liquidity concerns. Having said that, I do not want to close my door completely. Personally I want to hear about opportunities in the AI area. The reason is that the markets change, our risk-return profile changes and our asset size changes. Probably there should be a point where we invest. That is from a demand perspective.

The market is also changing from the supply side. Alter¬native investments provide flexibility to investors. The market is developing and the money is here [in Asia] among central banks and sovereign wealth funds.

If this group needs higher returns, and [alternative investments] has a more diverse group of funds, then they probably will work together, and the market mechanism will force them to move in the same direction. It is very difficult to see ahead five or 10 years, but if we go back to the year 2000, we were probably not looking at investing in global equities or emerging markets. So the door is open.

Q Do you see Europe as an opportunity?

A As an investor I have always seen bonds in Italy and Spain as an opportunity rather than a risk, if you claim yourself to be a long-term investor. The problem is that for official institutions like us, the risk-return profile is not symmetric.

The risk of fiscal crisis has been much diminished by the continued efforts of eurozone governments. As a central bank, however, we invest in those countries, cautiously reviewing the risks of them.

Q What is your risk-return profile?

A We used to say that the indicator of risk-return profile for us was the possibility of making a negative return for a pre-arranged time horizon, one or two years. That is one way to express it. Of course we have other symmetrical indicators.

We do not have a target return because everything is invested in our market portfolio, and how can you be sure what the markets will be like. What we have is a target of risk.

We do not want to make any mark-to-market loss for our portfolio on a one-year or two-year horizon. That would be a constraint on our portfolio optimisation model.

Recently we have also thought about the cost of our foreign reserves because we have foreign assets on one side, and on the other side we have domestic liabilities, so we try to match that and avoid a net loss on our income statement on an annual basis.

Q Can you outline your hiring policy at BoK and how it is changing?

A Traditionally we hire graduates and train them for years. But since 2005, experts from the private sector have also been employed through public contests.

About 20 of 90 personnel are working at our Reserve Management Group as of now. And also, we recruited the director of our reserve investment division and the head of our global credit portfolio team through public contest in 2012.

Q What was your return last year?

A We cannot disclose this, but you can probably guess from our asset-class composition.

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