Why NPS needs a permanent chief investment officer

The merry-go-round of top executives at South Korea’s National Pension Service (NPS) continues unabated. Impressively, it doesn’t seem to have dented the financial performance of the world’s third-largest public pension fund.

At least, not so far.

In the latest change-of-guard to the acting chief investment officer (CIO) role, Cho In-sik stepped down in July following an internal audit of the pension fund's support for a controversial merger between two Samsung affiliates in 2015.

Lee Soo-cheol then became NPS’s acting CIO, in addition to his role as head of investment strategy. He is the organisation’s second acting CIO in 12 months, following the resignation of CIO Kang Myoung-wook in July 2017. Meanwhile, the year-old search for a permanent CIO continues.

The lack of a long-term temporary leader, let alone a permanent one, is not conducive to continuity in investment policy. But the impact of this instability has been muted to date. NPS’s results for 2017 were very robust; it produced a 7.2% investment return for the year, fuelled by the soaring value of its domestic and global shareholdings as stock markets boomed.

Equities accounted for 38.6% of NPS’s portfolio at the end of December 2017, with its overseas shares generating an annual return of around 26% and domestic shares adding about 11%.

Other asset classes did less well for NPS last year. Alternatives, which accounted for 10.5% of its investment portfolio, returned 4.53%, while domestic and global fixed income yielded returns of just 0.51% and 0.14%, respectively. The Korean fund has 51% of its assets in fixed income instruments.

LUCKY?

To some degree, the absence of any negative fallout from the revolving door at the top of the organisation is not that surprising. The NPS is administered and managed by Korea's Ministry of Health and Welfare, and appointees to the role are often political in nature. The pension fund has numerous divisional heads underneath the CIO too, who do have to be more specialist in nature.

But in other respects that is mainly down to good fortune; NPS’s CIO-less vigour in 2017 was likely down to plain luck as global stock markets rallied, as much as anything else. 2018 is turning out to be an altogether different ball game, with international trade frictions escalating, global economic growth becoming less synchronised and Western monetary policy slowly being tightened.

That in turn is worrying equity markets. The S&P 500, which tracks the US’s largest listed companies, is up 5.4% so far this year, but that compares to the 17.4% return recorded across 2017. China’s Shanghai Composite Index, which tracks the Shanghai Stock Exchange, has fallen 13.11% over the same period, while the Korea Composite Stock Price Index is down 7.1%.

It is also reflected in NPS’s performance so far this year. Its portfolio of domestic equities fell 1.18% from January to the end of May, while global equities rose by 1.66%. Alternatives gained 2.17% while domestic and global fixed income offered year to date returns of just 0.45% and 0.3%, respectively.

Add into the picture NPS’s dismissal of its domestic equities head (and installation of another acting chief), and it looks increasingly unlikely that the asset class will offer the pension fund anything like the sizzling returns it supplied last year.

TRUE TEST

The coming months will show how well the organisation can ride out the increased market volatility and any unexpected disruptions without an investment chief overseeing its portfolio.

Currently, the Ministry of Health and Welfare leads the 20-member fund management committee (FMC) that makes important decisions regarding NPS’s investment management. The fund itself is entrusted with the administration and management of its assets (including making tactical asset allocations, investment execution, market monitoring and portfolio management).

The FMC’s decisions have to pass through a few layers of government before being approved. It’s a process that seems to have worked under normal market conditions, but it risks being overly bureaucratic when market conditions swing and the fund needs to respond with sizeable asset shifts.

The ministry’s committee is also in charge of setting out the NPS’s medium-term asset allocation strategy and its annual investment plan. For the 2017-2022 period it has set an annual return target of 5.1% based on its expectations of real economic growth and inflation. The target portfolio at the end of this period is to have about 45% in equities, 45% in fixed income and 10% in  alternatives.

Based on its last known weightings that suggests the fund needs to plough more assets into stocks in the next few years, while cutting back on its fixed income holdings.

While the NPS investment team is believed to operate with a high degree of independence and look to a CIO only for overall guidance, a more permanent CIO can monitor market developments closely and implement such strategic shifts at the right time. A politically minded FMC is likely to be much slower to react to fast-moving market events.

Having a CIO on a more lasting basis could also help the pension fund continue to improve its due diligence and risk-management processes, something former CIO Cho had said was a priority.

JEONJU JUJU

Complicating the hiring process is the 2017 relocation of NPS’s investment headquarters to Jeonju, a province more than two hours away by road from Seoul (and 1-1/2 hours by train).

The shift has not gone down well with investment specialists and has led to a steady drawdown of portfolio managers across departments, according to senior executives at fund managers and peer pension funds in Korea who have previously spoken to AsianInvestor on condition of anonymity.

In short, the fund has so far struggled to find enough suitable candidates with the specialist investment skills required in Jeonju.

The Korean fund continues to issue job notices on its website, calling for applications from candidates with expertise in private equity, real estate and infrastructure, as it continues to diversify away from low-yielding fixed income. But with an acting global alternatives head, it’s possible that the best and brightest applicants will be put off from applying as they wonder about the staying power of their prospective bosses and, consequently, investment decisions. 

With global markets turning more volatile, NPS looks increasingly in need of a permanent CIO – one who isn’t just parachuted in by government but has the right investment credentials to successfully navigate the growing uncertainty and attract qualified executives to help NPS invest its swelling chest of retirement savings.

2018 could make that need abundantly clear.

Ernest Chan and Richard Morrow contributed to this story.