KIC invests up to $900 million in ‘active’ index strategies

Sovereign wealth fund Korea Investment Corporation (KIC) has moved to invest up to $900 million of assets into three FTSE index products based on the strategies of active managers.

KIC has adopted this combination of developed non-market-cap-weighted index strategies within its public markets investment programme as it targets improved risk-return.

The stocks in these indices were picked by external managers and compiled into indices on a fundamental or risk-adjusted basis.

Scott Kalb, who joined KIC as CIO in April 2009, says that KIC has a total of $45 billion in AUM, of which it plans to invest between 1-2% into these strategies. He notes that accessing an active strategy through an index is especially useful for organisations with internal passive capabilities.

“Typically you want to replicate various benchmarks internally, but it is also possible to replicate these FTSE indices,” he adds. “This way you are able to implement an active strategy and you can do it very cost effectively through your own internal benchmark replication desk.”

KIC was set up in 2005. When it first started investing, Kalb estimates that 70% of its money was outsourced to external managers, including passive and enhanced mandates, while 30% was managed internally. Over the past few years it has reversed those percentages, having built up its internal capabilities, and now 30% of its assets are managed externally and 70% internally.

“What we did was bring in-house those passive and enhanced mandates,” says Kalb. “There was no reason to be paying fees to somebody else when you could easily be doing it yourself. The fee budget we have got now in terms of our external mandates is completely focused on active alpha generation on the public markets side.”

Six months ago KIC finalised a new internal organisational structure in its investments division, splitting it into three: public markets, private markets and a strategy group.

Its public markets segment consists of internal and external fund management, subdivided into publicly listed equities and publicly traded fixed income. Its private markets segment comprises alternative investments – private equity, real estate and hedge funds – and special investments, where it takes direct stakes in companies. The strategy group focuses on strategic and tactical asset allocation.

“There has been a big shift and the focus for our external [managers] is on alpha, not beta,” explains Kalb. “Now we can manage money very cost effectively on a passive or enhanced basis. The question is how can we improve the returns on that? One of the ideas is, instead of replicating just benchmark indices, why not try to replicate some active strategies and see how it works?

“So this is a further piece in the puzzle, another way to try and add some value on a cost-effective basis. We are starting this out in the 1-2% range and we’ll see how it goes. If it works well, we will consider expanding it.”

Paul Hoff, director of business development for FTSE Group in Asia, notes that many sovereign wealth funds and public and corporate pensions are looking for what he calls alternative beta, to try and get better returns with less risk for largely passively managed funds.

“The world’s largest funds have been among some of the early adopters of these strategies,” he says. “They are always looking for ways of getting around many of the problems of a straight market-cap index, where prices tend to be volatile and move on a wide variety of factors.”

FTSE’s risk-adjusted strategies involve quantitative assessment of the risks of individual stocks, with various estimates made off these profiles.

“There is a way of combining the data into a matrix which creates risk-adjusted stock weights for the portfolio,” explains Hoff. “The result is a better risk profile for the portfolio, usually from a bottom-up approach, stock by stock, making these adjustments and putting it all back together. These are growing in popularity.”

Hoff says KIC is the first institutional investor in Korea to license fundamental and risk-adjusted index strategies for its funds. Outside of the country, he says six fund managers and trust banks are licensed to use them in Japan, creating comingled funds which corporate pensions invest in. There is now $2.9 billion worth of investments in these fund strategies in Japan.

Hoff also notes that there has been a healthy take-up of investment in Australia into fundamental indices, both among superannuation funds and large government funds, while a couple of corporate pension funds in Hong Kong are also invested in this fundamental strategy.

Earlier this year, FTSE won $3.3 billion in Taiwan pension mandates, with the island's Public Services Pension Fund picking its FTSE All-World Index as benchmark for its $600 million global developed-equities mandate.

Taiwan’s Labour Pension Fund (LPF), which already benchmarks against the FTSE All-World Index, extended that relationship by allocating $1.8 billion to track the fundamentally weighted FTSE RAFI All-World 3000 Index. LPF also allocated $900 million to the FTSE EPRA/NAREIT Global Real Estate Index.