Seeking yield in safe assets

Lee Dong-ik, Korea Investment Corporation.
Seeking yield in safe assets

Lee Dong-ik became chief investment officer at Korea Investment Corporation in April, replacing Scott Kalb. He expects the $47 billion sovereign wealth fund to hit $50 billion in assets under management by the end of the year and $100 billion in 2017.

Q What are your main investment objectives?

A We run two broad asset classes: public securities – that is, bonds and equities; and alternatives, or private markets. We invest in the former for alpha – or relative return – and the latter for absolute return.

For the public securities, we have a one- and three-year target that depends on the market situation; that is inflation plus a certain amount that I can’t disclose.

On a three-year rolling basis we are getting a very healthy return on our alternatives portfolio.

Q What’s in the alternatives portfolio?

A Private equity, real estate, hedge funds and ‘special investments’; that is, direct investments such as into resources or infrastructure.

Q Can you only invest in foreign assets?

A Yes, we are supposed to manage Korea’s excess foreign reserves – they are already in foreign currency, so it doesn’t make sense to put them back into won.

Q But I understand you want to invest in some domestic assets?

A We’d like to see changes in the law to give us a chance to have some limited amount in domestic assets. I don’t know the timeframe; we are still discussing this with government and legislators, and nothing is yet determined.

If it happens, it will be somewhat limited – for example, co-investment with other global investors into Korean assets – and in private rather than public markets.

Q How is your portfolio broken down by asset class and geographically?

A Public markets make up 85%, split 50/50 equities/ fixed income. Alternatives make up the other 15%, with a fairly even spread across investment types.

We started investing in alternatives three years ago, and it’s now a growing portion. We hope to see it grow to 20% or 25% in the next few years. In terms of geographical allocation, KIC is pretty much following global benchmark weightings.

Q What’s the lowest bond rating you can invest in?

A We have certain guidelines agreed with our sponsors on both developed-market and emerging-market debt. Increasingly we have found emerging-market debt is attractive, especially under the current market situation.

Q How about your approach to equities?

A Our strategic equity allocations are largely benchmark-driven, but separately the tactical allocation depends on our house view and can be moved; we can make adjustments around the benchmark.

There are also some risk guidelines, such as around the level of tracking error.

We agree our strategic asset allocation with our sponsors periodically, and it doesn’t move much, while we can change our tactical asset allocation as often as we want.

Q Has your allocation changed in recent months or years?

A We try to maintain certain allocations, but in certain circumstances we can change our allocations. Also, we try to balance between in-house management and hiring external managers.

Q How big is KIC’s investment team?

A We have 130 people in total, around half of which are investment managers. We added some 20 staff this year, mostly on the investment side, including analysts and traders.
We have a long-term plan to double our AUM within five years and the investment staff will grow accordingly.

Q In its early stages in 2006, KIC outsourced 60% of its assets to external managers, but by 2010 this figure had dropped to 29%. What is it now?

A We can’t disclose numbers, but we are assessing internally whether to increase this portion.

Q How do you choose managers and how often do you review them?

A There are different schedules for different types of manager, but we don’t change them very often. Once you hire firms investing in private markets, for example, it’s quite long term. For public market managers, once we have a select pool, we just add or remove from it. We tend to prefer active managers to passive ones.

Q You received a QFII quota earlier this year. How will you invest it?

A We have finished preparing to deploy the $200 million QFII quota and will do so over the next few weeks, mostly into equities. We will invest it both through our in-house team and using external managers.

Q Do you use exchange-traded funds?

A We are open to most instruments, but we like to have an active component – we don’t want to be wholly passive. We have a quant model internally for equity and fixed income; based on that we like to add some active factors to create alpha.

Q How are you dealing with the current low-yield environment in terms of finding returns?

A That’s the most important question now. It’s everyone’s problem, and we expect to see a low-yield environment for an extended period. It’s very tough to find quality in safe places. There’s a flight to quality, but you need a certain level of returns, which is a big challenge.

We constantly discuss internally and with our sponsors whether there’s any way we can adjust to find the best way to cope with the market situation.

One interesting direction could be to use more of an absolute-return ingredient in our current mandate – but that’s not been decided as yet. That would probably involve looking at more exposure to alternatives and some rebalancing of the public securities portion.

I don’t think it’s fair to ask your public-market managers to create absolute return. They try to create alpha, but we try to find a way of adding an absolute-return component to the overall portfolio. That’s easy to say, but very challenging to do.

Q KIC has appointed a panel of transition managers. How have they performed and how much do you use them?

A We only need to use them occasionally. We do most of our portfolio restructuring/transitioning internally. Of course, if there’s a big shift in the portfolio, we would use them, but on an ad hoc rather than ongoing basis.

Once you’ve experienced a big portfolio shift once, you’re capable of rebalancing the portfolio with low cost.

Q How concerned are you about the FX-overcharging issues around firms like BNY Mellon and State Street?

A We are aware of the issue, but we can’t name specific custodians. We are analysing how we can improve pricing.

I don’t think it’s fair to demand full transparency; we know the embedded-cost issue is a part of business. But if we think there’s any way to improve the transition process, there has to be more emphasis on issues like expense reduction.

Hopefully there will be some pre-emptive improvement [by certain custodians] before investors like us take other measures.

Q Do you use derivatives for hedging or investment?

A We use them for some off-benchmark equity and fixed-income assets. For the overall portfolio, we are adopting tail-risk hedging, since as a fiduciary manager we need to allow for unexpected market moves. We use a lot of derivatives for tactical asset allocation.

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