[Interview] NPS CIO says may commit further 1.5 trln won to hedge funds in 2016

  • 2016-05-19

– Plans additional 1.5 trln won allocation after 1 trln won commitment to funds of funds in H1

– To diversify alternative asset classes to distressed assets, timber and commodities

– Sees alternative asset size up by over 10 trln won by end-2016 and by 70 trln won through 2021

 

By Dong Wook Jwa & Chang Jae Yoo

The Chief Investment Officer of the National Pension Service (NPS), Myoun-wook Kang, announced a plan of committing up to 1.5 trillion won ($1.3 billion) to hedge funds as early as this year, in addition to the allocation of 1 trillion won to funds of funds set for the first half of this year.

“We will additionally pick hedge fund general partners (GPs) within this year at its earliest to commit up to 1.5 trillion won,” Kang said in an interview with the Korea Economic Daily in May. “In order to diversify alternative asset portfolios, we will gradually expand to distressed (asset) funds, timber funds, or the like to which we have not invested yet.”

In the interview conducted ahead of the ASK 2016 Global Private Debt & Equity Summit hosted by the newspaper in Seoul, the CIO said that alternative assets of the pension fund at home and abroad will surge by more than 10 trillion won in value by year’s end, and by 70 trillion won through 2021, in line with the asset growth of the $440 billion fund. The portions of overseas and domestic alternative assets will be around 6 to 4.

Kang was appointed as the CIO of the NPS at the end of last February. Before joining in the pension fund, he served as the head of the Seoul office of ABN AMRO Asset Management and the CEO of Meritz Asset Management. Prior to the stints, he worked for Schroders Investment Management and Shinhan BNP Paribas Asset Management. He is known for his expertise in international financing and marketing.

The following are Q강면욱1&As with Kang.

▷How are you preparing overseas investment with what strategy?

“In a big picture, the size of alternative investments should increase. According to the latest mid-term asset allocation plan, a decision was made to do so. Now that the asset size of the NPS has been growing, we face limitations on domestic investments. We have to expand portfolios, too.”

▷Under the mid-term asset allocation plan, the portion of alternative investments has been unchanged for five years since 2012. There is a call on the NPS to raise the portion.

“Although the portion remains the same, the size of alternative assets will grow in line with the asset growth of the NPS. According to the mid-term asset allocation plan, the value of alternative investments, which was worth around 54.6 trillion won at the end of last year, will swell by more than 70 trillion won to around 130 trillion won in five years through 2021.”

“Six years later, the assets of the NPS will swell close to 1,000 trillion won, 1% of which is as much as 10 trillion won. It is becoming more difficult to find investment targets. By the end of this year, we are aiming for 12% of alternative investments, which means we have to raise (alternative investments) by more than 10 trillion won in value.”

▷How much portion does overseas alternative investments make up of your total alternative asset portfolios?

“The portions of overseas and domestic assets are about 6 to 4.”

▷There are views that because of uncertainties over financial markets recently, NPS is reluctant to invest in so-called “big deals,” worth some trillion won.

“Our principle is making a decision on a deal-by-deal basis. We do not make an investment decision based on its size. For big-size deals, our recent investments were mostly made through the bidding process. In this case, there is a high likelihood that the bid price may be set higher than the actual value. We take a conservative approach to investment proposals in which corporate value is set higher than the actual value.”

“For pricing, we are trying hard to adhere to our discipline. That is why the NPS is seen not participating in big deals, recently.”

▷Isn’t it just that there was a smaller number of big deals?

“Regarding infrastructure assets, there are a few of deals under way in Britain, Australia, etc. Considering the public role of pension funds, we are principally looking at assets that have legal protection.”

▷For overseas infrastructure investment, we are wondering which GPs you may prefer.

“We prefer to invest in core assets. We have to look at those with a less downside risk principally.”

▷Asset prices in core regions have gone up substantially around the world. What would you think about value-added or opportunity investment?

“We are continuously fine-tuning investment strategy. When it comes to real estate and infrastructure assets, we mainly look at the assets in core regions which generate consistent cash-flows. In this point of time, it is difficult to find assets such as Gatwick Airport in Britain, from which we can make capital gains through (a stake) sale or re-cap.”

“Assuming that capital gains would be low or non-existent, we are looking for assets for a long-term investment.”

▷How much returns would you expect?

“For real assets, it is about 4~5% plus consumer inflation rate. As far as we know, pension funds in other countries are expecting a similar level of returns.”

▷What would you think about investment in timber and farm?

“We are planning to invest through funds. Last year, we committed about 100 billion won to (funds investing in) farms. Regarding timber, we are studying an investment for this year. The investment, if executed, would not be big. You can understand that we are in the beginning stage.”

“In our view, (timber and farm) are not as much volatile as we previously thought. We will make a decision on whether or not to expand (investment out there), after monitoring returns.

▷Are there any other asset classes to which you would like to diversify?

“We are set to initiate investment in hedge funds. Regarding commodity investment, we have not received approval from the fund management committee yet. We are expecting that once hedge funds yield returns, commodity investment will win approval.”

▷What is your timetable for hedge fund investment?

“For the present, the fund management committee set a ceiling (on investment in hedge funds) at about 0.5% (2.5 trillion won) of our total assets. The selection of fund managers hinges on CIO. We are planning to commit about 1 trillion won in aggregate through funds of funds to two GPs.”

▷When would you expect to make an additional investment?

“For the time being, we are expecting to invest through funds of funds. Upon completion of the first-round investment, we will immediately get down to studying (an additional investment). We are expecting to make an additional investment either at year’s end or early next year.”

▷Are you going to change hedge fund managers whenever you make a new investment?

“We have not thought about it yet in detail”.

▷When you choose hedge fund GPs, what would be key elements under consideration among track records, key man, investment strategy, etc.?

“Our scorecard is not biased towards a specific element, but well-diversified. That is, we are not weighted towards a certain strategy. It is done in such a way that consulting firm Mercer prepares a shortlist and outside experts make a final decision on the GPs to which we will entrust our money. Fund managers of the (NPS) Investment Management group compare the consulting reports of Mercer with the due diligence results to find any difference between them. The shortlist was originally scheduled for (May) 18 or 19, but it is getting delayed slightly.”

▷For hedge fund management, it may be advantageous to pick a GP that is able to employ various strategies, not biased towards a certain strategy.

“Most of GPs with strong track records employ various strategies. There is no reason for NPS to insist on a certain asset class and take a risk. NPS also aims to learn various investment strategies and characteristics of hedge funds by investing through funds of funds. Once we gain more confidence in hedge fund investment, we may be able to expand our investment to a single fund GP, rather than funds of funds GP.”

▷What would you think about investment in activist funds?

“Practically speaking, it seems difficult (to invest in those funds) for the present.”

▷We would like to have your views on distressed asset market.

“Not only NPS but also global pension funds had set out asset allocation plans based on the prospect that opportunities would arise in distressed (asset) markets after the 2008 financial crisis.”

“However, as central banks took accommodative monetary policy as if they spray money out of a helicopter, distressed market conditions didn’t arise. Consequently, distressed (asset) funds underperformed.”

“However, going forward, we are expecting the opportunity will come up to increase the portion of distressed (assets). Regarding the pace of an increase, we will make a decision, in sync with market conditions.”

▷There are views that foreign buyout funds are struggling. M&A financing markets are also frozen.

“Overall, it is unlikely that the portion of buyout PEF funding shrinks this year from the 2015 level. M&A financing market is highly volatile on a monthly basis. In Europe, private debt funds (PDFs) are stealing market share of banks in the lending market. It is because banks were forced to sell loan portfolios in the face of tightened banking regulations. From the perspective of the NPS, it can be seen as an investment opportunity.”

▷If so, you may invest in PDF in Europe.

“We are studying it now.”

▷For real estate investment, which regions are you focused on?

“Among developed countries, there are regions in which we have not invested yet. Canada and Northern Europe were one of them. Recently, we made an investment in Canada.”

▷NPS is criticized for its long and complex investment process. By comparison, foreign pension funds, which are competing with the NPS, are making speedy investment decisions to improve their investment competitiveness.

“When it comes to alternative investment, it is true that it takes long time to study. For a certain case, it took six months. Considering the risks associated with alternative investment, it may be unavoidable to take long time. For now, we have no plan to change such a process.”

▷Since you took office as CIO, some say NPS has been tightening risk management further.

“We have not lengthened the process. It can be understood that we strengthened post-investment management which we had hardly cared about before.”

“We do not intend to strengthen (risk) management in the pre-investment stage. In the past, NPS tended to neglect post-management after investment was made. From the standpoint of fund managers, it was inefficient to keep monitoring past investments when new investments were flowing in. That is why we have set up a team in charge of post-investment management. For overseas investments, our foreign offices will take charge of post management.”

▷Such a move may dent investment sentiment for fund managers.

“Before my inauguration last February, NPS started discussion to strengthen post- management of alternative investment. As a result, a post-management team was established last March and a decision was made to subdivide the risk management center by alternative asset class.”

“It does not mean we will invest only in safe assets principally and keep away from risky assets. Instead, in order to diversify our investment assets and proceed with investment in emerging markets, we have to take preemptive action to beef up risk management and post- management.”

▷How is it going to revamp your organization to combine domestic and overseas alternative investment teams?

“It is not right to carry out reorganization whenever a new CIO takes office. There is no reason to attach or detach a team every two to three years. If there is a problem with management efficiency, the problem is not about an organization but about people. After we recently established a team-based unit such as post-management team of alternative investment, I don’t feel the need of reorganization.”

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