Resource shortages plague Korean pension funds

Even the mighty National Pension Service lacks the internal capacity required as it and local peers expand international investments.
Resource shortages plague Korean pension funds

Public pension funds in Korea may be amassing huge amounts of assets but their internal staff resources are not keeping pace, forcing them to seek more external partnerships and managers.

The problem is acute for mid-size funds such as Korea Teachers Pension Fund and the Government Employees Pension Service, but it applies also to the national giant, the $306 billion National Pension Service (NPS).

“NPS’s peers in Europe, in Norway and the Netherlands, have far greater internal resources,” notes Lee Insup, AsianInvestor’s Korea correspondent, speaking at our annual Korea institutional investment conference held in Seoul. “So Korean investors have to invest indirectly, via funds or funds of funds. It’s a big problem for asset owners here.”

Lee Kyung-Jik, head of global equities and fixed income at NPS, says the organisation’s contributions are growing three times faster than its benefit outlays, and its AUM is on track to hit W2,500 trillion ($2.1 trillion) in the coming years. “We must make good use of these inflows to boost returns on investment,” he notes.

Although a large fixed-income allocation is important, to provide downside protection for the NPS’s 19 million members, its large size is forcing NPS to invest abroad. This creates additional risk, so it has to diversify.

In May, the NPS board decided to change the strategic allocation, which will see it reduce its 64% exposure to fixed income down gradually to 56% over the next five to 10 years. More domestic bonds will shift to equities, while overseas it will add equities and alternative investments.

Today the NPS has W42 trillion ($37 billion) in overseas equity and fixed-income positions. That amount will double over the next five years, with particular focus on China and the US, as well as a desire to tap new growth markets. “We must outsource more but we do lack the resources,” says KJ Lee.

The situation is similar for smaller public funds. The Korea Teachers Pension Fund (KTPF) today has W10 trillion ($8.8 billion) of AUM, a size that will triple by 2013, says CIO Lee Yun-Kyu. However, the fund size will peak by 2023, after which it risks total exhaustion if its structure goes unchanged.

KTPF, therefore, also needs to boost returns, which is why it plans to raise its international allocation gradually from 20% to 40% over the next several years. But it has to rely on external managers, and is looking for funds in equities and fixed income.

“Except for the NPS, Korean pension funds lack international experience,” says YK Lee. “We need outside managers for overseas investments.”

He says funds are examining global providers across multiple criteria, including reliability, transparency, track record, management process, systems and structure, and client service.

The Government Employees Pension Service (GEPS) is in an even more difficult situation: its AUM levels continue to grow (W8 trillion, or $7 billion), but its payouts outweigh new contributions, and the government pays it W2.5 trillion annually in subsidies to keep the fund operational.

To meet its requirements, GEPS targets an annual investment return of 6.8%, which has become difficult now that domestic interest rates have fallen to 3%. This is leading the fund to raise its equity allocation from 25% today to 35% over the next few years, says CIO Yoo Seung-Rok.

GEPS, like other Korean public funds, invests in alternatives and wants to grow this. GEPS’s allocation is already 16%. But most of this is domestic; one attempt to buy buildings in Manhattan went awry because GEPS bought at the 2007 property market peak.

“We have no offshore expertise, which is why our total international allocation is only 1.3% of AUM,” says Yoo. This limits GEPS to investing via funds, or funds of funds. “We do need to diversify because the domestic market is too small,” he says.

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