Korean investors want EM debt, alts…some day

For many insurance companies, pension funds and banks, the need to diversify bond portfolios abroad is understood, but few seem prepared to act.
Korean investors want EM debt, alts…some day

Several insurance company and bank investment officials in South Korea say they recognise the need to diversify bond portfolios to international assets, but are uncomfortable taking on the associated risks.

Similarly, second-tier pension funds accept the need for alternative investments, but aren’t ready to take the plunge.

Speaking at AsianInvestor’s recent Korea Institutional Investment Forum in Seoul, Kim Joong-il, CIO at Hyundai Life Insurance (a post he has just stepped down from), says overseas investments are attractive but the firm’s bond portfolio will remain onshore for the time being.

At Hyundai Life, 53% of the portfolio is in fixed income. Aside from a few holdings of dollar-denominated bonds issued by Korean corporations, it is all domestic.

The short-term outlook for Korean fixed income is favourable, as interest rates are not expected to rise anytime soon. Indeed, on the morning of AsianInvestor’s event, the Bank of Korea surprised the market with a 25 basis point cut in its benchmark rate, to 3%.

Domestic corporate-bond spreads are narrow, so there is little opportunity to achieve big capital gains, but fears about global risks and their potential impact on Korea’s economy is keeping investors in domestic bonds, Kim says.

Yoo Joong-yol, managing director at Korea Reinsurance Investment Advisory, says investors including insurers and benefit associations need to go abroad to extend asset durations. But problems in the eurozone as well as concerns about US fiscal surprises (i.e. the ‘fiscal cliff’) are deterring action. Similarly, the popularity of emerging-market debt among Western investors has made Korean bonds all the more attractive, as demand for them rises.

That demand is bringing stability to the Korean bond market, particularly to the US dollar market for Korean issuers, which has seen $15 billion worth of new issuance so far this year.

But that isn’t enough to convince many investors to venture abroad, says Timothy Lee, fixed-income manager for the proprietary desk at Dongbu Savings Bank.

He says given doubts about Europe and the US, investors in Korea are focused more on finding yield. “You can’t build a portfolio until there’s action on the eurozone, the US fiscal cliff and the prospect of another round of quantitative easing,” he says.

He believes that emerging markets such as India and Indonesia offer compelling assets, thanks to still-high interest rates. “By investing in their treasury bonds or credit-default swaps, we can get the kind of returns that Korean companies used to offer,” Lee says.

Hyundai’s Kim agrees. “If we seek absolute returns, we should consider emerging-market debt.” But it’s hard, given changing accounting standards and risk-based capital rules that are forcing insurers and benefit associations to minimise portfolio risk. “Many investors fear going to overseas markets,” he says.

It is a similar situation for alternative investments. Although the country’s biggest investors, such as National Pension Service and Korea Investment Corporation, are chasing deals in private equity and real estate, the next tier of funds have yet to follow in a meaningful way.

The Government Employees Pension Service, for example, plans to increase its exposure to local private equity and venture capital funds, says Kee Hyuk-do, head of its alternative investment team. He recognises that GEPS’s allocation to alternatives, now 15% of AUM, needs to increase, probably to 20%.

But the due diligence required can be daunting. And while falling interest rates and sideways stock markets argue for more alternative exposures, these assets are also subject to liquidity risk, exit risk, and often unattractive pricing.

Moreover, GEPS is not ready to take on international alternative exposures, which now comprise only 2% of its AUM. One solution might be co-investing or a club deal. “We want to share the investment and liquidity risk with others,” says Kee.

One of the more aggressive investors in alternatives is the Korea Securities Finance Corporation, which invests nearly 20% of its W5.5 trillion into private equity funds, mezzanine funds, venture capital and derivative strategies.

KSFC’s head of asset management, Jung Hyun-jong, says he wants to increase this to 30% of AUM. A former investor for Samsung Life Insurance, he recognises the benefits alternatives bring to controlling total risk. “I prefer products with income,” he says, adding that hedge funds’ track record is poor, so he’s not ready to consider them.

Instead he will focus on buildings and other real-estate opportunities, particularly if distressed European banks are selling them. Jung adds that the regulation in Asia and other emerging markets is too challenging; he prefers to stick with Europe and North America, where the rules are more clear.

Kee agrees: “We’re comfortable with developed markets,” because emerging markets create additional headaches around hedging and taxation. He also likes the idea of investing in overseas real estate, but core assets don’t offer sufficient returns to justify the hassle. That is leading him to seek gatekeepers or consultants to help identify private-equity or real-estate funds.

Matthew Murphy, a fixed-income specialist at Eaton Vance Investment Management, which has a fixed-income hedge fund, says some funds do have a strong track record. He suggests alternatives of any stripe should deliver “beta you don’t already have”, and advises institutions to stick with those funds that have demonstrated solid performance throughout the investment cycle.

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