Is it time to cut Asia’s asset owner giants down to size?

The assets operated by a few Asian asset owners amount to more than the gross domestic product output of all but the very largest global economies. And they are set to keep rising.

At the end of 2020, Japan’s Government Pension Investment Fund (GPIF) had $1.56 trillion in assets under management. Korea’s National Pension Service (NPS) possessed $588.97 billion in January, and it is set to rise to over $1 trillion by 2025. And China Investment Corporation (CIC) has over $1 trillion in assets, three-quarters in local financial institution state assets via subsidiary Central Huijin Investment.   

Having such an enormous pool of assets confers many advantages, but also sizeable drawbacks.

Asset owners with hundreds of billions of dollars under their belt enjoy economies of scale, which allow them to employ more internal specialists for relatively less. They also possess bargaining clout when negotiating external manager or service provider fees. And, at least in the case of sovereign wealth funds, having heft is a reward in itself; it projects the nation's power. 

But economy-sized funds come with plenty of inertia too.

Too much scale can leave the organisations lumbering and bureaucratic, not least because they are often overseen by government agencies - particularly state pension funds. Plus, they can end up overly exposed to their home markets.

Korea’s NPS has long been been the biggest fish in a mid-sized pond, owning approximately 7% of local shares. That has given it some headaches. Indeed, a Korean parliamentary report in August 2020 noted that “as a single entity, [NPS] creates a problem in operating its fund, given that its assets are too large for the size of the local financial markets”.

It has been looking to diversify into assets in higher growth markets, but these plans made it an easy target for local retail investors when the Kospi benchmark stock index suffered a sustained falling during March into April (never mind the fact that the Kospi surged by 30.8% in 2020).

NPS ended up softening a planned reform to its investment target into local stocks, a compromise that leaves it vulnerable to further retail investor pressure.

CONSEQUENCES OF GROWTH

Despite such difficulties, the region’s institutional giants have coped with their scale relatively well.

NPS’s annual investment returns averaged at 5.95% since 2010, while CIC’s annualised cumulative return was 6.6% in the decade to 2019. GPIF’s annualised return has been a less impressive 2.39% since 2001, but it has been based on a virtually zero-growth economy with no inflation, making this adequate for its needs.

But the bigger they get, the harder it becomes to diversify their portfolios.

And grow they will. Korea’s government has predicted NPS’s assets could top W2.56 quadrillion or $2.69 trillion, by 2043. Meanwhile GPIF’s AUM may hit $2.1 trillion by 2030, and $4.4 trillion by 2080.

CIC, with its three-tier structure, is better diversified than its state pension peers. However, its AUM will also keep mounting as China’s economy continues to grow lustily.

Diego Lopez, managing director of Global SWF, notes that great scale can confer diversification difficulties. He noted that Norway’s Norges Bank Investment Management discovered this when deciding to invest 7% of its asset base into unlisted properties, while keeping its policy of investing in prime locations.

“That meant that they had to deploy tens of billions of dollars in cities with limited investment opportunities,” he told AsianInvestor. “They failed to do so and had to revise their target to 5% (the actual number is still 2.5%).”

BENEFITS OF DIVISION

One way the asset owners are likely to respond is by adding internal investment experts and more global offices.

A report by PwC entitled ‘Sovereign Investors 2020’ predicted more big sovereign investors will bulk up internal investing staff “in an effort to internally execute mandates previously allocated to external firms or to invest in new asset classes,” while adding more international offices.

Some already have. GIC of Singapore, for example, has 16 offices around the world, CIC has one in New York, and NPS has offices in New York, London and Singapore.

Others are seeking more innovative solutions. GPIF’s relatively small investment team has to invest its assets with external managers, and mostly does so passively. They have sought to overcome their limited internal resources by building artificial intelligence solutions to better assess their external manager partners.

In addition, Japan's prime minister Yoshihide Suga said he will look at implementing an independent board to direct GPIF, replacing the direct oversight of the Ministry of Health, Labour and Welfare.

However, another way exists to make these investors more effective: cut them down – literally.

A GPIF that was separated into three $500 billion pension funds, or five $300 billion pension funds, would still boast size and negotiating heft. But each smaller organisation could, at least theoretically, adopt its own investing specialisation, perhaps focusing upon domestic investing, private assets, or long-term infrastructure and sustainable funding.

Such specialisations might prove necessary. As Gary Smith, managing director of Sovereign Focus, argues, breaking a major fund down into smaller generalist ones could simply cause them to double up on identical holdings and end up bidding against each other for similar assets, driving prices up.

Plus, smaller entities would lack the sort of sustainability investing drive that the likes of GPIF have also been able to bring to bear on fund managers and investee companies.

"There are some benefits to reducing the size of funds, but there are definite disadvantages too," he said.  

However, Lopez notes that some countries have pursued such structural changes to their investing champions with some success.

“For example, the Nigerian Sovereign Investment Authority (which was created in 2011) has a Stabilization Fund, a Future Heritage Fund, and an Infrastructure Fund, and that has helped them isolate and overcome the capital withdrawal they suffered during 2020,” he noted. He adds that Chile’s ESS-PRF and Kuwait’s GRF-FGF have adopted similar strategies, to at least some degree of success.

As Asia’s top echelon of investors by assets continue to grow, they will struggle to fend off political pressure and still reach their investment targets. That may well lead to more discussion about breaking them into smaller entities. 

The approach has its merits, and could make specialised investing easier – but it will only work if it is very carefully plotted, with areas of specification carefully mapped out for each institution. 

Big is not always beautiful – but the best things don't always come in smaller packages, either.

The views expressed here are those of Richard Morrow, editor of AsianInvestor.