2019 has offered Korea’s institutional investors two key lessons. First, overseas asset exposure cannot be overstated. Second, the need for corporate governance reform has never been more vital.
The country’s export-oriented economy has been on its slowest growth track in a decade, due in large part to the mounting tensions between vital ally US and key neighbour China. Added to this, President Moon Jae-in’s leftist government has been seen as anything but business-friendly, sources tell AsianInvestor.
And most recently, Korea has become embroiled in a trade row with Japan, which imposed export controls on high-tech materials to South Korea. This move could badly hit the country’s tech manufacturing industry because it affects key materials needed for chip and display production. Many of Korea's large tech conglomerates, chaebols, are expected to be hit, such as Samsung Electronics, SK Hynix and LG Display.
These pressures have steadily built up. Korea recorded meagre GDP growth of 2.7% in 2018, while in the first quarter of this year it contracted by 0.4%. The Bank of Korea reported on July 25 that GDP rose by 1.1% during the second quarter but it evidently feels this to be a fragile recovery; a week earlier on July 18 it unexpectedly cut its benchmark interest rate by 25 basis points, its first such cut since 2016.
This difficult economic environment has had a big impact on Korean asset performance. The interest rate cut means new credit assets will offer even lower returns for local investors, while geopolitical tensions have hammered local equities. Korea’s benchmark Kospi Composite Index dropped by 18.28% during 2018, and while it rose by 2.8% this year as of Friday (July 26) this is well short of the S&P 500’s 20.55% return or the Shanghai Composite Index’s 19.48% performance over the same period.
Worse, a prolonged or worsening period of tension between the US and China could cause Korea’s weak recovery to relapse.
The generally weak performance of local assets helps explain why several of its larger pension funds in particular have sought to invest more overseas. Korea’s National Pension Service stands as testament to both.
The world’s third-largest pension fund, which has assets under management worth W701.2 trillion ($592 billion), garnered negative publicity when it posted a 0.92% investment loss for 2018. And while many institutional investors struggled in a year in which most asset classes faltered, NPS’s local investments were a particular drag on returns.
Its domestic equity allocation fell 16.77% over the year, whereas its overseas equities dropped 6.19%. The pension fund is aware of this weakness, and it intends to increase its overseas exposure from 32% at the end of March to up to 50% by 2024. It also made changes to make investment processes nimbler for professionals in its overseas offices in New York, London and Singapore.
Many of Korea’s other leading pension funds have seen the necessity for making more overseas investments, but they are still mostly domestically focused.
Investment consultancy Mercer found in its 2019 Wealth Asset Allocation report that pension funds in countries like Korea, Japan, Malaysia, Taiwan and others had raised foreign asset holdings, but foreign fixed income constituted just 16% to 23% of total fixed income, while foreign equities were 45% to 49% of overall equity allocations.
This home bias is understandable but it could prove a liability. The country’s economy is at best growing weakly, and the increasingly adversarial relationship between the US and China looks likely to last – bad news for Korea’s reliance on exports. Plus its population is aging fast – over 20% of its population will be over 65 by 2026.
The country’s funds need to make more money, and fast. Taking a take a leaf out of NPS’s book and raising overall asset exposure to around half would be one wise step.
A second would be for Korea’s pension funds to push for corporate reform at home.
The country’s chaebols are notorious for dominating its industrial markets, holding an insidious and sometimes corrupt influence in local politics, and possessing labyrinthine cross-shareholding structures.
Essentially, the families behind the chaebols have maintained complete control of their conglomerates despite only owning a minority of their shares by having divisions hold stakes in each other.
This web of shareholding has allowed them to largely ignore minority shareholders and pursue their own agendas – to sometimes selfish or corrupt ends. The widespread nature of this practice has led to the infamous ‘Korea discount’, with foreign investors refusing to value shares of chaebol divisions as highly as international rivals.
The consequences of this extend beyond share valuations. Former president Park Geun-hye was impeached and, last year, imprisoned over her collusion with a long-term friend to take bribes from conglomerates including Samsung Group. NPS was also implicated, with the country’s former health minister being jailed for pressurising the pension fund to provide crucial support to a merger of two Samsung subsidiaries at a valuation that was seen as unfair to minority shareholders.
Moon’s administration, no friend to big business, has signalled its desire to combat the more pernicious actions of the chaebols, while NPS underscored its desire to be a stronger advocate for corporate governance. It signed up to Korea’s stewardship code in July 2018, while its vote against the reappointment of the chairman of Korean Air helped ensure he had to step down.
While NPS could do more, other pension funds should follow. So far none of them apart from NPS has signed up to the stewardship code, according to the Korea Stewardship Code Council. They should all do so, and follow this by asserting their rights as shareholders and investors in chaebol divisions. If the funds work together, they may be able to force the chaebols to become more accountable – hopefully making them better run, and narrowing the Korea discount.
Korea’s pension funds should invest more offshore, but it’s likely they will always keep most of their money onshore. Given that, they may as well ensure the companies they invest in are well-run – and properly respectful of their minority owners.