Two of Korea's most powerful institutional investors are tightening the control they have over their alternative investments, wary of a possible future "day of reckoning" given high current valuations and the liquidity limitations of the asset class.
At an investment conference on Wednesday (April 10), sovereign wealth fund Korea Investment Corporation (KIC) and Public Officials Benefit Association (Poba) signalled their intention to tweak their strategies because of the market's lack of transparency and the potential ramifications if conditions sour.
From the podium at AsianInvestor’s 13th Institutional Investment Forum Korea in Seoul, Kang Shin-woo, KIC's chief investment officer, noted how the abundance of capital since the global financial crisis had fuelled an explosion in private equity markets and alternative investments generally.
“We all have to wonder how much longer and further this will last, and how we should respond to this megatrend,” Kang said.
The total amount of private equity and venture capital secured in 2018 was $432 billion, down 24% from the record $566 billion raised in 2017 but still in line with levels seen in previous years, according to specialist data provider Preqin.
Another source familiar with the internal operations at KIC told AsianInvestor on condition of anonymity that the sovereign wealth fund is increasingly focused on the lack of mark-to-market valuations on alternative investments, which could become an issue in future if a recession drives down liquidity.
“The only reason that alternatives are seen as having lower volatility is that private equity is not mark-to-markets like public equity, and that blurs the actual valuation,” the investment official said. “As alternatives become a main asset class to invest in, you must wonder whether a day of reckoning will eventually come for investors.”
He said KIC still sees value in alternative investments as a tool for diversification but now wanted to increase its direct investments in alternatives, and to strengthen its internal investment capabilities, to gain further control of the underlying assets.
“For alternatives investments, we mainly invest through external managers or [general partners], but we are gradually increasing our direct [investments] and co-investments with reputable GPs,” Kang said from the stage.
KIC has assets under management totalling about $140 billion. Traditional assets make up about 80%, with equities and fixed income about evenly split, while alternatives make up slightly more than 16%.
The plan is to increase that to 20% “over the mid- to long-term”, Kang said.
“As alternatives are taking a larger share of AUM, it is always important to internally discuss whether it is actually decreasing overall portfolio risk exposure,” Jang Dong-hun, CIO of Public Officials Benefit Association (Poba), told AsianInvestor in an interview on the sidelines of the event.
“We have to be wary and raise questions about allocating to the right risk-return profile for alternatives,” Jang said. “It is not sustainable to play the cycle because no one knows when it turns.”
And such worries are not confined to South Korea or even Asia alone, he added, noting the Who's Who of asset owners from around the world that had discussed similar themes at the recent Global West Government Funds roundtable in London.
TAKING THE JV ROUTE
Jang agreed with KIC’s efforts to tighten the control it has over its alternatives allocation by investing more directly but it's not an option open to Poba.
So, instead, the state retirement scheme has been looking to move more into joint ventures.
An example of this is Poba's joint ventures last year with California State Teachers' Retirement System and Teacher Retirement System of Texas to invest in US real estate debt.
Jang said he is now considering new joint ventures with other global pension funds.
“Alternatives can never be totally safe in case of an economic downturn. By entering joint ventures, Poba gains ownership and control to normalise and reconstruct the underlying alternatives assets, compared to investments in blind or commingled fund vehicles,” Jang said.
Poba has an AUM of $11 billion, of which 58% was in alternatives at end-2018. The retirement fund for local government employees has reduced its allocation to global equities by 40% since the end-2017.