Korea's Government Employees Pension Service (GEPS) is set to shrink its fixed income portfolio in favour of alternatives over the coming five years, as it seeks to better diversify its asset allocation and improve its risk-return profile.

Richard Park Chunsuk, head of investment strategy, told AsianInvestor that the fund had not made any significant portfolio moves as a result of the low-interest-rate environment. But that is now set to change, as it plans to reduce its fixed income exposure gradually due to concerns about the potential impact of a rate hike.

Fixed income makes up 48.1% of GEPS’ W7 trillion ($6.3 billion) in assets under management. It aims to winnow this amount down to 45.4% by 2021, while raising its alternative allocation from 16.9% to 24.3% over the same period. The fund has a long-term return target of 4.5%.

In addition to cutting overall bond exposure, Park said the portfolio was also shifting more into overseas fixed income products, such as structured notes and credit bonds.

AsianInvestor reported in April that GEPS was aiming to raise alternatives and overseas allocations by the end of this year, in line with its state pension fund peers. Park’s comments make clear that this is part of a longer-term asset re-weighting.

One example of the fund's rising allocation to alternatives was its move in May to invite bids to run two global private equity secondaries portfolios for a total of $100 million.

GEPS is also looking at investment options via exchange-traded funds, which it became the first Korean pension fund to invest into last year. Park said he liked the fact they were low-cost in transaction terms and could be implemented quickly.

The move into ETFs has also helped underpin GEPS’ decision to increasingly insource the management of some of its bond and equity portfolios. It set up an internal overseas investment team in 2014, which will increasingly take on some of its overseas passive assets.

“Internal investment has some merit because we can select some specific individual investments directly, like regional or country ETFs and structured notes,” Park said.  

For the longer-term, he said he was most concerned about a sudden upwards move in interest rates. The Bank of Korea cut its benchmark policy rate to 1.25% in June, but he suggested a sudden reversal could leave many local pension funds exposed.

Such an upwards move could generate negative returns in fixed income portfolios, because their duration has become quite long due to today’s low interest rates, Park noted, making them more vulnerable to interest rate hikes.

Look out for the full interview with Park Chunsuk in AsianInvestor’s September edition.