Diversification has become a mantra for Korea’s LP community. The majority are invested inside the country – and this strategy has come up short, according to several Korean LPs speaking at PEI’s Global Alternative Investment Forum in Seoul in June.
Korea’s soft domestic growth (forecast at 2.6 percent this year) and low interest rates have made pension funds and other entities, already pressured by payment obligations to the country’s ageing population, desperate for higher returns.
Many are taking quick steps to put capital to work in alternatives outside Korea.
“Inside Korea, the value of our assets is depleting,” said Min Ho Park, chief investment officer at the $8.8 billion Korea Teachers’ Pension Fund (KTPF). “We have to expand our investments overseas.”
Investments in alternative asset classes used to be optional for Korea’s institutional investors, who have tended to focus squarely on domestic investments, explained Yun Kyu Lee, KTPF’s former CIO. “Now it’s a must. They are rushing toward it. But many do not have enough experience.”
(Exceptions are Korea Investment Corporation and the National Pension Service, who both invest actively outside the country, though these entities only opened foreign offices for the first time in the last three years).
Going abroad without foreign investing experience creates risk for these risk-averse pension funds. Speakers at the Forum such as James Ahn, managing director at Clayton, Dubilier & Rice, suggested funds start by building a five-to-ten year investment blueprint.
“Put together a broad blueprint from the board or government agency overseeing your institution and get behind a five to ten year plan to agree on. Only a few institutions have done that.”
Having this blueprint will also help funds survive senior executive turnover, which Korean institutions typically have every few years due to the business culture, Ahn said. “In Korea, organisations tend to encourage developing all-rounders rather than narrow expertise in one area and that results in internal changes.”
In addition, Korean LPs need to look at scaling their teams relative to the size of opportunities targeted. “Resourcing is not where it needs to be, and that puts a lot of pressure on the teams. Except for 1-2 sovereign wealth funds, most teams I’ve seen in the region are sub-scale for what they are trying to achieve.”
Jim Hildebrandt, managing director of Bain Capital Asia, suggested some concrete steps as well: decide on what proportion the institution wants in alternatives, then decide the percent to allocate offshore, and finally, think long and hard about fund manager selection.
“If you’re re-entering private equity or going into it the first time, it make sense to consider either larger funds or fund of funds because they are the ones who can come back to Korea on a regular basis and provide regular reporting,” Hildebrandt said.
The Korean LPs’ push into alternatives for higher returns is part of a broader challenge to pension funds globally, according to a recent data-backed study by Partners Group.
For example, continental Europe, UK and Swiss pension funds have more than half their current allocations in bonds and cash (US pension funds have 29 percent). While such a strategy worked well in the past, the low interest rate environment drains yield, inevitably leading to missed targets on returns. The performance of public equity portfolios is unlikely to fill the gap, the study said.
Without a rebalancing of portfolio allocations to increase exposure to alternatives, pension funds face “the very real risk of not being able to fulfill payment promises to pensioners”, according to the study. ?