Opinion: Will Korean pension funds slow their alternatives allocation?

Already 10 years ago, predictions were made that Korean investors would move heavily into alternative investments.

Also read: Expect Korea wave into alternatives

Since then, Korean asset owners have indeed shown a profound interest in and ability to diversify their portfolio into alternatives - more so than their Asian peers. Pension funds and mutual aid associations have especially allocated a considerable amount of their capital to private market assets globally.

Also read: Korea tops Asian pensions with $101 billion invested in alternatives

While the alternatives wave is likely to continue, there could be indications that the demand could be curbed during the coming investment calls from Korean pension funds and mutual aid associations for several reasons.

Also read: Korean investors crave cross-continental opportunities

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As mentioned, some Korean pension funds and mutual aid associations already have a relatively high share of their portfolio invested into alternatives. From a risk and diversification perspective, there is a limit to how high an exposure is considered wise.

As interest rates will keep rising in the US in particular, Korean investors are likely to consider whether fixed income will regain the attractive risk/return profile it once had, with or without hedging costs. Relative to alternatives, fixed income and government bonds provide a certainty of return that any pension fund will seek for its members.

The challenge of alternatives is still the lack of a marked-to-market valuation, especially at a time when both global and regional uncertainties might shift the economic and financial odds out of favour going forward. In unstable markets, transparency and familiarity will have increased appeal.

Sources familiar with the thinking of investment managers at Korean pension funds and mutual aid associations tell AsianInvestor that a trend of primarily sticking to known alternatives investment might become prevalent. For instance, the investors will likely allocate to their preferred investments by re-upping mandates to commingled funds or allocating capital to subsequent platforms within the same fund series that has shown to perform.

In terms of diversification, Korean pension funds and mutual aid associations are likely to show increased interest in multi-asset class investments to increase the diversification of an overall portfolio through one asset manager, instead of several different managers. Asset managers providing such multi-asset solutions are likely to see more interest from some Korean investors.

CURRENCY CONUNDRUM

On August 30, 2021, one US dollar cost 1,165.51 Korean won. On August 30,  2022, that same US dollar cost 1,345.21 Korean won, an increase of 15.4%. With the US being the world’s largest and most sophisticated market for alternatives, the exchange rate brings further considerations for Korean investors.

While some relatively large pension funds or mutual aid associations invest directly overseas into commingled funds from asset managers, others work with domestic asset managers that then pool capital together from several asset owners to a combined mandate. That mandate is then invested in one or spread across several funds or direct ownership of assets, such as a property often brokered by Korean securities firms, depending on the strategy.

Also read: Korean brokers take global alternatives push to new level

In both models, but especially the latter, the currency risk comes into play as capital is not invested right away. In fact, capital can be lying dormant as “dry powder” without being invested for quite some time, sources explained AsianInvestor.

With private market valuations being less transparent and locked in long-term compared to liquid public market investments, there can be both a steep change in price and exchange rate cost when capital calls are finally being made. And the same issue will occur if the underlying assets are to be sold off at a later stage.

Currency hedging can of course help this problem significantly. However, with such a massive cost, Korean investors might as well take that hedging cost within fixed income instead, where they know the risk and return more clearly.

PIGGYBANKS FOR PRIVATE HOUSEHOLDS

The private economy of Korean citizens seems likely to be impacted directly and indirectly by the recent interest rate hikes around the world, including Bank of Korea’s hike of half a percentage point on July 13.

Although Korea’s household debt fell to 104.3% of GDP in the first quarter of this year from 105% in the same period a year earlier, it is the highest level among 36 major economies, according to the Institute of International Finance, a Washington-based private financial industry association.

In Korea, individuals can take out a loan at their pension fund or mutual aid association. These loans have relatively attractive interest rates compared to bank loans or credit card debt. Thus, it is not uncommon for Koreans to pay off these loans with a less expensive loan provided by their pension scheme.

Although not yet at a critical level, this trend of lending money to pension savers is likely to have an impact on the liquidity and amount of dry powder this year for pension funds and mutual aid associations, sources tell AsianInvestor. Relatively lower capital to deploy makes investors less likely to venture into new, unknown asset types, but stick to traditional and well-known assets, both in terms of types (equities, fixed income) and within alternative investments specifically.