This article appeared in the October 2012 edition of AsianInvestor, and was the winning entry for Jame DiBiasio being named Journalist of the Year for pensions issues at the 2013 State Street Institutional Journalism Awards, Asia Pacific.

Korea’s National Pension Service turned 25 years old last month. Like a vigorous young person transitioning to adulthood, NPS has weathered its share of growing pains and is now confidently taking on the wider world.

Its assets under management hit W380 trillion ($340 billion), and by the time you read this article, it will probably have become the world’s third largest public pension fund, nudging ahead of the Netherlands’ ABP. (Only Norway and Japan boast bigger ones.)

NPS’ asset growth will continue for another 30 years. It is projected to hit W924 trillion by 2020 and peak at about W2,465 trillion in 2043.

It is now responsible for providing financial security to 20 million Koreans, with over 3.3 million already receiving benefits. The country’s low birth rate and extending rates of longevity mean that, despite NPS’ formidable asset growth, it will struggle to provide the necessary social insurance. It therefore must strive to boost investment returns over the long haul.

“On current demographic trends, NPS’ assets will become depleted, so this is an urgent challenge,” says Kim Hwang-sik, prime minister of the Republic of Korea.

Its size and growth prospects make NPS the most important institution in Korea’s capital markets; without NPS money, many local fund managers would go out of business.

Increasingly NPS is becoming a major player on the international stage. It is now one of a handful of (mainly) Asian and Middle Eastern institutions with the size and scope to get what it wants – and, if it isn’t careful, to move markets.

So far it has shown skill, with three-year annualised performance of 7.3%. That’s good for a fund of this size, particularly given the rocky nature of financial markets these days. Much of that outperformance is due to recent moves into alternative investments, which last year posted returns of 12%. 

Governance concerns
However, although the NPS is now a grownup peer to the world’s biggest institutions, it is still often run more as an adolescent. Until a few years ago, its investment staff grew up as bureaucrats seconded from the Ministry of Health and Welfare. Although that is no longer the case, there remain concerns that NPS is still run to serve Ministerial or governmental agendas other than protecting Korean citizens’ nest eggs.

“The autonomy of the NPS is critical,” says Yun Chang-hyun, president of the Korean Institute of Finance. “The NPS needs to know its purpose,” he says, noting that a fund of such size and power can cause side effects if mismanaged.

He recommends making NPS “fit for purpose”, meaning given the necessary independence from the Ministry of Health and Welfare to become more professional and focused on investments – including changing staff compensation to reflect the private market.

Park Sang-yong, a professor at Yonsei University, praises NPS’ evolution towards ‘patient capital’ but wonders if deals in infrastructure and real estate risk politicization; he too says NPS’ legal status should be changed to make it more independent.

(NPS chairman Jun Kwang-woo says these concerns are overdone; see our accompanying Q&A.) [We will republish the Q&A next week.]

Kim Hyoung-tae, president of the Korea Capital Markets Institute, notes that NPS has evolved into a gigantic financial institution – he calls it a “superpower in global investment markets because of its AUM” – but it is regulated as a government agency.

Kim’s worry is that this discrepancy will hamper NPS’s ability to invest well enough to extend its lifespan beyond 2043, at which point not only will its asset size decline but benefits will exceed contributions. NPS in its current configuration will be there for the current generation of workers, but not their children.

Other voices in Korea’s capital markets would like to see NPS’ weight more actively harnessed to advance the nation’s financial institutions.

For example, Ryu Sang-ho, CEO of brokerage Korea Investment & Securities, says NPS capital can help Korean banks and asset managers expand operations overseas; in turn, as their global operations are seeded, they can help NPS manage more international exposures, instead of relying wholly on US and European counterparts.

Choi Suk-yoon, head of Goldman Sachs Korea, argues the reverse: that foreign banks’ role in Korea is limited, so NPS can use its origination and placement power to help bring global products to Korean investors. It can also use its leadership position to expand currency, swaps and other cross-border markets.

Finally, some people want to see NPS advance corporate governance in Korea. Kang Byong-ho, president of the Korea Corporate Governance Service, says minority shareholders struggle to effect change among Korean corporations, but NPS has the heft to impact behaviour.

In a similar vein, Oh Gyu-taeg, professor at Chang-an University, would like the organisation to build an in-house team dedicated to socially responsible investing. 

Diversifying abroad – with friends

The move to become such an organisation is relatively new. NPS always had some modest international exposure. That took shape first under the chairmanship of Park Hae-choon, the first NPS CEO from the private sector (he was previously CEO of Woori Bank). He set out the first allocations to alternative investments, for example, such as acquiring the HSBC building at Canary Wharf and the Sony Centre in Berlin. But the 2008 global financial crisis overwhelmed his initiatives, and NPS slashed its international portfolio by a third, to $20 billion.

It has been under the current administration of CEO Jun Kwang-woo that the NPS has put globalisation front and centre. Jun’s background is a mix of private sector (a previous vice chairman of Woori Financial, chairman of steel giant Posco) and government (founding chairman of the Financial Services Commission, a cabinet-level post).

One of Jun’s first acts upon taking the reins in 2010 was to not renew the contract of the serving chief investment officer, who was viewed in the marketplace as competent but lacking the international experience necessary to drive NPS into international equities and alternative investments.

Jun’s next move was to elevate the compliance role: with the group expanding into direct investments in global property, he wanted a direct line to the team overseeing due diligence.

Third was to build on early stabs at forming strategic alliances with financial institutions to help gain access to opportunities, as well as train its staff.

Officials at NPS, who requested anonymity, say this approach has changed over the years to something more focused on performance. NPS doesn’t like to talk about these relationships in detail, but three years ago it inked deals with Credit Suisse and Morgan Stanley. That line-up has changed, but it has also expanded.

Titans of Wall Street now consider NPS a key client, as attested by video presentations to the NPS and its guests at a 25th birthday celebratory conference held at the Shilla Hotel in Seoul on a stormy Monday in September.

The thrust of these congratulatory messages was the same: NPS was becoming a titan of its own on the global stage, thanks to its huge asset size but also because of its vision to diversify and be an active global asset manager.

These relationships are not just to leverage NPS into global markets, but to take advantage of the post-crisis turmoil. NPS’ leadership understands this is a unique moment for a long-term investor – for “patient capital”, as termed by economist Larry Summers – to pick up attractive assets in the West.

Summers was at hand to mark the NPS’ silver jubilee. He was the US Treasury secretary during the 1997-98 Asian financial crisis, a humiliating experience for Korea. Today of course Korea is one of the world’s biggest, most dynamic industrialised economies, while the US is mired in debt and recession.

NPS is reacting to this by shifting out of an overreliance on fixed income. As a pension fund, it has a natural need for bonds, but the 2008 panic saw NPS flee to the safety of domestic fixed income. That allocation has since fallen from 78% of AUM to about 60% for domestic bonds and 8% for international bonds.

Over the next three to five years, NPS plans to boost equities to above 30% of AUM, and alternatives to more than 10%. Global exposure will grow from about 15% today for all assets to at least 20% in 2017, says Jun. Today NPS outsources W132 trillion ($117 billion) to international fund managers, and twice that amount to Korean firms.

To make this work requires not just strategic relationships, but also an internal network. To that effect, NPS opened an office in New York in 2011, followed by London earlier this year.

Jun, whose three-year term is about to end, says NPS is looking at opening a third office in Asia next year. The fund is reviewing the obvious candidates such as Hong Kong and Singapore, as well as other possibilities.

Fourthly, NPS is one of only two pension funds in Asia, along with the Government Pension Fund of
Thailand, to sign the United Nations’ Principles of Responsible Investment. To that end it has seeded a domestic fund based on socially responsible investments, although it has yet to take stronger steps as an activist owner of Korean companies.

But as the comments cited above made at the 25th anniversary conference by local academics and financial players attest, NPS is more than just an investment group. It is custodian to tens of millions of people’s retirement savings, in a country where the demographic picture threatens to eventually wipe out NPS’ assets. It is subject to a variety of demands and projections of hopes and fears.

The fact that these issues were raised at the NPS’ own conference, however, demonstrates a remarkable confidence. What makes NPS unique among Asia’s biggest institutional investors is that it exists in a vibrant, noisy democracy.  That makes Korea a transparent society, and NPS officials do welcome open dialogue.

Far from being a hindrance, the public eye gives NPS’ leaders a daily reminder of their mission, requires them to justify their actions and ultimately legitimises their strategies. By such standards, NPS is truly Asia’s leading institutional investor.