Korean asset owners are increasing their qualitative assessment of external managers as they move into global and alternative markets, in part to avoid time constraints in the traditional due diligence process.
Speaking at AsianInvestor’s 9th annual Korea Institutional Investment Forum this month, panelists also admitted that knowledge transfer and training was often a determining factor in choosing which manager to outsource to.
Asked how they went about selecting external managers, typically the panelists used a dual system. Primarily they resort to request-for-proposals (RFPs), issuing an investment mandate and inviting managers to pitch.
Once pitches are received, they use both quantitative screening and qualitative assessment. Managers are shortlisted and invited to make a presentation before further due diligence is carried out and, finally, selection made.
“We normally follow this classic system,” said Park Min Ho, chief investment officer at the $10.6 billion Teachers’ Pension (TP) fund. “We want managers with a long-term track record.
“But alternative investment is different. Relative comparison and benchmarking is not easy. Therefore we need other criteria, so we have a one-off [selection] system.”
TP has set out ambitious plans to expand into international and alternative assets, as reported. Park outlined the fund’s asset allocation as 67.7% equities, 17% fixed income and 14.9% alternatives, with the remainder in cash. It uses 51 external managers in total, with 100% of its alternative exposures outsourced.
Kang Sung-Seog, head of global investment at the $20 billion Korean Teachers Credit Union (KTCU), agreed on the importance of selecting the right manager, but said there was a need to balance fairness (giving firms the same opportunity to pitch) with identifying effectiveness. This is dictated by the fact it is a public institution.
He, too, highlighted how it used a quantitative and qualitative process, emphasising market reputation and track record, while at the same time recognising the different funding requirements in dealing with private equity and real estate managers.
Similarly Choi Young Gwon, chief investment officer at the $3.5 billion Government Employees Pension Service (Geps), acknowledged the need for it as a public institution to be seen to be fair in its selection.
“We want to pursue the first track [RFP process],” he told the forum. “But it normally takes at least three months, which is time consuming and makes it difficult for us. We have to look to reduce the time, so we have to have a one-off system as well.”
Asked how to differentiate between managers that were performing through luck or through skill, Choi pointed to long-term track record, giving a three-year timeframe a 70% weighting in its decision-making and one-year 30%. He added information ratio, or risk-adjusted performance, was also something it concentrated on.
But what was new for the institution this year, he added, was focusing more on qualitative assessment in the selection of external managers. He added it wanted to diversify away from the Kospi index as a benchmark for selection in future.
Kang of KTCU agreed, noting that what aspects of beta or alpha it focused on varied and depended on timeframe. “Therefore we decided to strengthen our qualitative assessment,” he concurred.
Cho Sung Sik, managing director of the $20 billion Mirae Asset Life Insurance, said the RFP process was time-consuming and that institutions needed time to use it. It uses 30 external general partners (GPs) at present.
Cho noted the firm went through a detailed due diligence process to put managers on a watch list and, after further monitoring, an investible list. “We build a strong database for each asset class,” he said, pointing out it has plans to expand its absolute return strategy over time.
He said he looked at managers’ track records and the logic of their investments to see whether alpha was sustainable, while adding Mirae liked managers that offered training opportunities.
“We have meetings with different shareholders and we know what kinds of decisions are being made and the different functions of each team. Then we can understand what process they are using,” Cho said.
Park noted that to determine whether true alpha was being generated, TP firstly checked if a manager’s investment process matched its investment philosophy. “There could be an issue of style drift,” he stated.
But he said that when it was seeking managers with overseas expertise, if all other things were equal TP would likely prefer the firm that offered knowledge transfer and had a strong infrastructure or local presence in Korea.
“Knowledge sharing is important,” agreed Kang of KCTU. “We want the opportunity to get a good relationship with general partners [external managers].”
On the question of sacking managers, Cho of Mirae said that performance mismatch between managers could lead to one firm being replaced by another.
Choi of Geps said it was more concerned about tracking error and whether managers were diversifying away from benchmark.
Park added that while TP wanted to be able to see external managers achieving the goals set out in a mandate, there was also a time limit. “Sometimes we cannot wait for them to achieve that because we have our own time constraints,” he explained.