Opinion: Time for Korea's NPS to go big or go home

Feb 15, 2023

Korea’s state pension is projected to run dry in 2055. A more daring return strategy and more overseas diversification could be tools to extend longevity.

Go big or go home.

The saying refers to going all out or putting all of one's effort into an enterprise. For Korea’s National Pension Service (NPS), managing the world’s third-largest pension fund, that might be just what it needs to do with its investment strategy.

NPS is facing a challenge from the demographic development in Korea, as the number of retirees set to receive benefits from the fund increases.

Under the current asset management system, the NPS fund will hit W1,760 trillion ($1.37 trillion) in 2040 and then reverse course to be depleted by 2055, according to new data from a financial estimation committee.

However, the fund’s life can be extended by eight years if the annual rate of return increases by 100 basis points, analysts say.

It seems rather straightforward to suggest that increasing the risk-adjusted return will increase the probability of extending the fund’s life further.

INCREASING OVERSEAS ALLOCATION

In June 2022, NPS said it will decrease its dependence on domestic stocks and raise the holding of foreign stocks in its portfolio to 40.3% by 2027. The figure is much higher than the 27.8% it held in November 2022, according to most recently published data.

For domestic equity allocation, the target for 2027 is set at 14%. As of October 2022, the fund has allocated 15.1% of its portfolio to domestic stocks.

Albeit that is a significant shift towards foreign equities, the question is whether NPS could go even further.Another asset owner giant, Norway’s Government Pension Fund Global, also known as the oil fund, has about 70% of total portfolio invested in equities globally.

Such a high allocation to equities will of course mean large fluctuations in annual performance, as was the case for the oil fund in 2022, but it ought to provide better returns for a long-term investor like NPS.

For instance, the MSCI ACWI index that covers 85% of the global investable equity opportunity set has had an annualised net return of 8.24% over the last 10 years, and 5.7% since 2000.

HOME BIAS

Beyond a higher equities allocation, NPS ought to consider whether the exposure to domestic assets should decrease further than the projected share.

As the fund is projected to grow at least a couple of decades more, the domestic share could generically be brought down without divesting simply by exclusively making overseas investments.

Investing overseas will also increase diversification and reduce reliance on the Korean economy, which will face challenges due to demographic changes.

Also read: Home bias takes a toll on performance for Korea’s NPS

Although the logic of investing abroad and using the profits on retirement at home seems obvious, it is unlikely that such a clearcut strategy would be carried out. NPS faces political influence and is seen by some as a tool to fuel the domestic economy and the shape financial markets in Korea.

Also read: Political meddling a liability for public asset owners

If NPS be allowed to intensify its hunt for higher returns overseas, as well get a leg-up with general pension reforms in Korea, the likelihood of a longer lifespan would increase significantly. As it stands, it looks like the fund has no other choice than to go big or go home.