Korean pensions eye private debt amid PE concerns

Korean institutional investors are increasingly eyeing niche private debt as a result of high equity valuations, low bond yields and heavy exposure to other alternative assets, chief investment officers said at AsianInvestor’s Korea Institutional Investment Forum in Seoul yesterday.

The Public Officials Benefit Association (Poba) has seen private fixed income instruments grow to account for 6% to 7% of AUM and the allocation will continue rising, said CIO Jang Dong-hun.

“Whether it’s local bonds or overseas credits, corporate bonds are not sufficient [in terms of yield] to reach our target return [of 5% to 6%],” he said. “So to enhance this we issued structured notes, invested into private debt funds and mezzanine instruments.”

Kang Sung-seog, CIO of Korea Teachers’ Credit Union (KTCU), said the W24 trillion fund had adopted a similar strategy in its search for returns.

KTCU is interested in direct lending and collateralised loan obligations (CLOs) because of their attractive returns and relative seniority, he said. Even if the issuer of loans or CLOs has problems, the investor can recover some of the principal, noted Kang – which is not necessarily the case with bonds.

Big into PE and property

Another issue Korean pensions have is that some are already heavily exposed to other illiquid assets such as real estate and private equity.

Poba has around 47% of its W10 trillion AUM in such alternative investments, noted Jang. “We have a concern for the future about how much we can have in alternatives, and what the optimal level is.”

Poba is in some ways a victim of its own success. Jang said the strong performance of its overseas alternatives portfolio had meant the allocation had risen by six or seven percentage points in recent years. 

“In the past it was a niche market, but globally the low-rate market has led it to become a main investment area,” he said, noting that private equity investing was encountering new challenges.

KTCU’s Kang agreed that the flood of capital into PE over the past two years had made it a more challenging space to invest in. “In its growth phase you could reap some profits [quite easily] but today, depending on the skills or competencies [of the private equity managers], your results can vary widely.”

Hence the trend is for investors to be more selective of their private equity GPs, particularly in Asia, and to be more cautious about illiquid assets in general, given the lower returns they now provide.

KTCU also has almost half of its investable assets in alternatives, as it seeks to meet an annual liability rate of 3.6%. Traditional assets would not have achieved sufficient performance, he said.

But Kang is concerned about price levels, particularly in property. “The real estate market has risen to a high level,” he said. “Much of that is to do with a lack of supply, and we wonder how long it will last.”

Jang echoed his concern. Asset prices have gone up across all asset classes, he noted. “While fundamentals seem to be good it’s difficult to give prospects for the future, as geographic and political concerns emanate across the world.”

He said Poba was considering whether to make more use of tactical asset allocation – rather than strategic asset allocation – if risks do rise. 

While concerns are rising, the growing asset bases of pension funds forces them to seek assets that return more than local government bonds.

David Park, CIO since January at Korea’s Teachers Pension, said his fund was adding overseas and alternatives assets. It now has 23% of its W15.6 trillion in AUM across those two allocations, up from 19% last year, and its exposure is likely to be 30% in four years’ time, noted Park.

Alternatives not always an option

However, alternatives are not the solution for everybody.

Cho Sung-sik, CIO of Mirae Asset Life, said the insurer had only invested 1.6% of its W20 trillion into alternative assets. It has no choice; most of its separate account assets are based on variable insurance policies, which are managed according to client needs and may therefore require liquidity at short notice.

This has forced Mirae Asset Life to seek higher-return areas of traditional asset classes. Its variable fund target returns range from 5% to 6% annually, and to reach that, its equity portfolio is 60% overseas, split evenly between developed and emerging markets, he said.

A heavy focus on equity has left Mirae Asset Life exposed to very highly valued markets. The US's S&P 500 benchmark index closed at 2,543.46 on Monday, setting yet another record high.

Mirae Life’s response is to focus on companies in rapid growth areas, namely e-commerce companies, said Park.

“Major IT companies have led the equity markets [globally] so far, and we are looking into whether that leadership will continue,” Cho said. He added that Mirae Life was seeking to underweight the healthcare sector globally due to the heavy regulation of pricing by goverments.

This story was based on quotes translated from Korean at the event.