How KIC is spreading the risk of its alpha assets

Korea's sovereign wealth fund is working to balance out risk factors in its portfolio and taking a flexible approach in ESG investments, it revealed in a webinar hosted by AsianInvestor.
How KIC is spreading the risk of its alpha assets

Korea Investment Corporation (KIC) plans to ensure that risks in its portfolio are diversified across a broad range of alpha sources after experiencing the market turmoil caused by the pandemic earlier this year.

The Korean sovereign wealth fund has seen the credit spread segment of its fixed income portfolio record the worst performance since March. The key is to maintain diversification not only in strategy but also in risk factors as well, Daniel Oh, the lead portfolio manager for fixed income external fund management, said in a webinar hosted by AsianInvestor in partnership with BNY Mellon on Thursday (October 29).

The common risk factors in fixed-income investments are interest rate risk, credit spread risk, default risk, exchange rate risk, among others, but Oh did not specify which of these in particular should be taken into account.

Daniel Oh, KIC

“Currently, we see some tilting towards certain risk factors due to a few managers. We are ready to balance them out during the next rebalancing period,” he noted.

Investment managers have different styles for generating alpha. For example, within the public equities asset class some investors focus on value, or fundamentally strong companies, while others prioritise growth strategies. Asset owners will typically analyse each manager’s underlying strategy and holdings and see how they have changed over time.

Oh said KIC, which has $157.3 billion in assets at the end of 2019, looks not just at investment performance but also the types of risk factors adopted by the fund managers it outsources to. In addition it considers whether the return performances match the intended risk exposures in their track records.

Risk factor-based allocation works by determining the underlying risk exposures that contribute to each asset’s returns, and then selecting assets based on those exposures. For instance, when KIC analyses external fund managers who focus on country selection and have duration or exchange-rate risk-factor exposures, it tries to balance out those exposures by selecting assets with different risk factors.
It will also analyse which risk factors can provide a better information ratio (IR), Oh said. IR is a measurement of portfolio returns that can be gained beyond the returns of a benchmark, usually an index, compared to the volatility of those returns.

The sovereign wealth fund had had 35.5% of its assets allocated to fixed income at the end of 2019; the second-largest share after equities (40.8%).

KIC is not the only institutional investor to emphasise risk factor diversification as part of building resilience in an investment portfolio. Japan Post Bank adopts a similar strategy.

Speaking in the webinar discussion, Tatsuo Ichikawa, managing director and head of quant team at the investment division of Japan Post Bank, said investors should monitor both the risk and regional concentration among asset classes in investment portfolios. Portfolios can be better managed when investors use risk factors rather than just tracking exposure and investment volumes, he added.


KIC's Oh also shared views on how the sovereign wealth fund sees environmental, social and governmental (ESG) investing, an area that has been gaining investor traction, especially during the pandemic.

While asset owners such as the Hong Kong Monetary Authority (HKMA) and Australia’s Aware Super heavily scrutinise potential fund manager partners to pick out genuine adherents, Oh said that KIC stresses “flexibility” when it comes to dealing with investee companies that have ESG attributes.

The ESG factor is only one aspect among several that KIC looks at when building a future proof portfolio. A long-term institutional investor often faces a situation in which some securities within the portfolio show promise in terms of returns but happen to have a low ESG score. KIC tries to be quite flexible in these instances, Oh said.

For example, a company with growth prospects may have exposure to coal fire plants, and so its ESG rating may not look as good as some others, he noted. In such an instance KIC would try to engage external managers to see if there are any means, such as starting a conversation with management, to help the company improve its ESG performance and align with ESG regulations, he said.

“While we are serious about ESG factors, at the same time as a long-term investor, we would like to be more flexible and cautious about the overall score,” Oh said.

His example was not snatched from thin air. Korea Electric Power Corporation, a state-affiliated electricity company, has come under a great deal of international asset owner and fund manager criticism for its willingness to invest in coal-fired power plants in Indonesia and Vietnam.

This investor pressure, along with the Korean president Moon Jae-in's commitment to shut down domestic coal plants and cut Korea's carbon emissions to net zero by 2050, led Kepco to announce on Thursday (October 29) it would not pursue any more such ventures, although it has resisted pressure to exit current projects. 

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