Korea’s Government Employees Pension Service (GEPS) is preparing to make investments into hedge funds having steered clear of the asset class in the past few years, joining other Korean institutional investors seeking cheaper and more liquid alternatives.

The news, exclusively revealed last week at AsianInvestor’s 12th Korea Institutional Forum, came as panelists discussed the best ways to manage the growing global economic risks as Western monetary policy is ever-so-slowly tightened.

The remedial action taken by major developed countries in the wake of the financial crisis led to a flood of money swishing around the global financial system as central banks bought back bonds from the market. That, together with historically low interest rates, was for a long time accepted as the new normal, Lee Chang-hoon, chief investment officer at GEPS, told the audience.

But things are changing, not least in the US where the Federal Reserve has begun to unwind its bloated balance sheet and has nudged up rates seven times, panellists acknowledged. 

“The US and others are selling bonds and the interest rate is increasing, and the EU will also shortly stop purchasing the bonds and may increase their interest rate, so there will be changes at all these central banks of the major economies,” Lee said.

The potential impact of rising interest rates, which could well include higher market volatility, means investors like GEPS are looking to increase investment in products that are uncorrelated to traditional asset classes.

“In the big picture, we increase investment in products that can help us to decrease the beta risks, and one of them is hedge funds that pursue absolute return,” Lee said.

GEPS currently has no allocation to hedge funds due to their lacklustre investment performance in recent years.

“The fact that we did not invest in hedge funds in the past few years was a good choice,” he said.

Korean hedge fund mandates produced returns of 13.35% in 2017, the second-lowest among the Asia-Pacific groupings used by data provider Eurekahedge. Korean three-year and five-year annualised returns also rank last with 2.32% and 5.03% returns, respectively, its data shows.

For all this, certain hedge fund strategies such as equity long/short, event-driven, and commodity trading advisors strategies can offer some downside protection against increasing market volatility – an attractive proposal for the Korean pension fund.

“Now we’re preparing to make an investment into hedge funds, so we’re making investments into hedge funds this year,” Lee said.

In so doing GEPS will join other Korean institutional investors finding a renewed appetite for hedge funds.

The Public Officials Benefit Association (Poba) has so far this year increased its hedge fund allocation by $60 million and it intends to bring that total to about $100 million by the end of 2018. Korea Post Insurance (KPI) announced a mandate in April 2018 for foreign hedge fund managers to oversee an additional 50% allocation to its hedge fund investment pool, which as a result now totals $280 million.

In the first quarter of 2018, the average allocation to hedge funds by Korean institutional investors increased slightly to 2.6%, compared with 2.5% throughout 2017, according to another alternative assets data provider, Preqin.

RECESSION FEARS

Alternative investments in general have proven popular with Korean pension funds.

“There are limited investment opportunities here in Korea, so that’s why we see more of the investors in Korea going to alternative investments,” Shin Hyun-jang, head manager of the Police Mutual Aid Association’s (PMAA) financial investment division, said on the panel.

The PMAA increased its allocation to alternatives to 45.3% in 2017, from 40.5% in 2016.

Poba has about 50% of its portfolio in alternative investments because traditional assets like equities and fixed income alone are insufficient to meet its return targets, Jang Dong-hun, chief investment officer at Poba, said on the same panel.

However, Korean pension funds with allocations to alternatives need to be prepared for a potential economic recession in 2019 or 2020, Jang said.

“Probably the next round of global economic recession will be experienced around that time, probably coming from the US,” Jang said on the same panel.

The US economy has been expanding steadily since June 2009, buoyed in part by accommodative monetary policies, but rising inflation and simmering trade tensions between the US and China could trigger a recession-like environment.

Should a recession take place, liquidity management is essential to navigate the challenges of a downturn in the market.

“Compared against traditional investments, alternative investments have lower liquidity, but when we have a stress situation in the future we have to know how quickly we can liquidate alternative investments,” Jang said.

This story is based on quotes translated from Korean at the event.