[ASK 2016 SUMMIT] S.Korea LPs say performance, communication as key elements for hedge fund GPs

  • 2016-05-23

– MMAA sees active portfolio rebalancing as key requirements for hedge funds; prefers advisory firm that can accord with MMAA strategy via communication

– KTCU considering setting up small- to medium-sized fund segment like NPS & KIC; sees performance and transparency as key factors to pick GPs

– Kyobo Life to almost triple hedge fund commitment to 200 bln won by yr-end after redemption at end-2015; sees performance, liquidity and communication as key to pick GPs

– KTCU and Kyobo shifting toward doing due diligence study on hedge funds on their own

In a panel discussion of the ASK 2016 Global Private Debt & Equity Summit hosted by the Korean Economic Daily on May 18-19 in Seoul, three leading limited partners (LPs) in the country shared their views and investment plans for hedge funds, and spoke of key considerations they make to select hedge fund general partners (GPs).

The following is the translation of the panel discussion in the summit.

Moderator: Raymond Kang, CEO at Prodigy Capital Management Panelists: 1. Chan Woo Kim, Senior Manager of Kyobo Life Insurance 2. Jin Woo Kim, Head of Alternative Investment Division of the Military Mutual Aid Association (MMAA) 3. Philip Yoon, Head of Alternative Investment Team II of the Korea Teachers’ Credit Union (KTCU)

▶Moderator: “Please introduce yourselves.”

▶Chan Woo Kim (Kyobo Life) (hereinafter, “Kyobo”): “I’m working for the overseas investment team. Our company has over 80 trillion won ($70) in assets, 10% of which, or 9 trillion won, is invested in overseas assets. Of the portfolios, hedge funds make up 30 billion won. We had held up to 120 billion won in hedge funds until last year.”

“After redemption at the end of last year, our hedge fund assets now stand at about 30 billion won. In the second half of this year, we will boost investments in hedge funds and raise the volume to 200 billion won.”

▶Jin Woo Kim (MMAA) (hereinafter, “MMAA”): “We are managing about 9 trillion won ($8 billion) worth of assets for soldiers and civilian military employees. Thirty percent is put in traditional assets such as equities and bonds, and 70% is invested in alternative assets such as private equity funds and private debt funds. Of alternative investments, the portions of domestic and overseas portfolios are 65% and 35%, respectively.”

“We are going to boost overseas alternative investments going forward. We started hedge funds investments in 2012 as part of risk diversification efforts. Now our exposure (to hedge funds) is over $100 million. Since the second half of last year, hedge funds have been underperforming. We are rebalancing some of the funds.”

▶Philip Yoon (KTCU) (hereinafter, “KTCU”): “I’m leading the Alternative Investment Team II of the KTCU. At the end of April this year, the KTCU had 27 trillion won ($23 billion) worth of assets, of which overseas assets represented 6.5 trillion won. To domestic alternative investments, our exposure is 5.8 trillion won. In 214, global alternative investment team was established. Global alternative investment team II invests in overseas PEs and hedge funds. Our hedge fund portfolios include multi-strategy and funds of funds. The outstanding value is about 250 billion won.”

▶Moderator: “Most of pension funds are pursuing 4~8% returns, which are hard to achieve from the traditional investment strategies. Fixed-income assets yield only 2% or less. Equities valuations are above their historical average in the wake of accommodative monetary policy. Where can you see a breakthrough in this circumstance?”

▶Kyobo: “Although the 10-year U.S. Treasury yield is 2% or less. It is still higher than domestic yields. We have diverted domestic investments to overseas assets. We are raising our exposure to alternative investments. While domestic bond portfolios earn 2% or less, those diverted to overseas (assets) are racking up 3~4% returns. We will overcome the crisis by allocating money to hedge funds and other alternative assets.”

▶MMAA: “For risk diversification, we are expanding alternative investments. We are diversifying return sources. Like Kyobo Life, we are increasing the portion of overseas investment, but it does not necessarily lead to returns. Rebalancing is underway on an ongoing basis. To find a breakthrough, our missions will include exploring a good manager.”

▶KTCU: “In the current financial environment, it is difficult to achieve a 7~8% return. PD or direct lending is possible because of tightened banking regulations in Europe. In addition to PE and PD, I also see hedge funds as an alternative. We are recently raising investment in hedge funds, although we started investment in them earlier on. In the recent two to three years, hedge funds have underperformed. That could be attributable in part to the economic cycles. Thus, we are expecting (hedge funds) to make a recovery for a medium term.”

▶Moderator: “Although hedge funds delivered poor returns, it did not apply to all of them. Even though there are no exact numbers, there are as many funds as 15,000 and 10~15% of them have good talent and performance. The key would be the capacity of adopting a strategy in sync with the global economic cycles and selecting a good fund, as well as portfolio structure. What would you think?”

▶ KTCU: “When hedge funds generate returns, we have to know if it is because of good luck or ability. We are studying a tool to verify it internally. We have made a medium-term review of past performance, and it was helpful. We are making a short-term or medium-term evaluation by strategy. For example, if we differentiate our evaluation of hedge funds by strategy, as if we split (the investment period) into a long term and a short term when investing in PD, we can make a tactical allocation. Doing a strategic rebalancing like the MMAA will help achieve steady returns.”

▶MMAA: “Fund reliability and portfolio structure are important. Since last summer, we have invested in hedge funds on expectations that they would yield appropriate returns along with appropriate risks. But they have underperformed in line with markets. Among traditional assets such as equities and bonds and alternative assets, the degree of distortions is high in hedge funds. Even within hedge funds and by strategy, distortion of returns was greater than other assets. Active portfolio rebalancing appears to be important to invest in hedge funds. To make an investment after understanding them, two to three years seem to be short. I will do more research and study in future.”

▶Kyobo: “Our company had invested in hedge funds before the financial crisis, but they were hit hard during the financial crisis. From the second half of 2014, we implemented hedge fund investments again. It is not easy for a general company to select a hedge fund manager. Looking back on our past experience, in the due diligence study we undertook based on basic company data and performance results, we assessed whether the company we had picked achieved good results. But it was not easy.”

“Implementing new hedge fund investment in 2013, we focused on selecting the firms that could help us. We had meetings with hedge fund LPs running funds of funds and hired one of them as an advisory firm to make a value investment. Until last year, we had 20 fund managers and earned profits through strategic allocation or rebalancing within them. We participated in the due diligence process on hedge fund managers together with the advisory firm, and experienced how to select a good fund manager. After the second half of last year when markets were not in good shape, we have sacked many (hedge fund) managers through rebalancing and secured only a few of managers. But going forward, we will put our efforts into securing a pool of new portfolio managers through cooperation.”

SHIFTING TOWARDS DUE DILIGENCE STUDY ON THEIR OWN

▶Moderator: “When it comes to due diligence study, do you make a due diligence review on domestic hedge funds on your own? Do you also conduct due diligence study on overseas hedge funds? If so, do you use due diligence-specialized firms and if so, how much do you pay them?”

▶Kyobo: “It is equivocal to say we do it directly or indirectly. We do it together with an advisory firm. The advisory firm undertakes due diligence study, and we observe it. After the due diligence process, we solve a question together and reach a decision. We are in the middle of doing it directly and indirectly. In future, we are aiming to do it on our own.”

▶MMAA: “Our company also worked with an advisory firm, taking a lesson from the mistake made by another financial institution. But there were limitations and problems with communications. It is not only about language, but also understanding a strategy and changing it, depending on market conditions. What matters is not simply having an advisory firm, but how they can accord with us.”

▶KTCU: “In the early stages, we had also conducted a due diligence study through an outside specialized firm. We didn’t just leave it to the outside firm, but we also participated in the process. The results were fine. But recently, when we invested in funds of hedge funds, we conducted a due diligence review on foreign GPs on our own. We were greatly satisfied with the results of our due diligence review. We have set our principle of doing it on our own in future and will go ahead with it, with some support from a foreign company.”

▶Moderator: “American pension funds invest in emerging managers which are small in size, but yield good returns. Are there any restrictions on investment in such funds? What would be the most important factors in selecting a fund?”

▶Kyobo: “Performance is the most important thing. We first select a fund, based on risk-adjusted returns which reflect risks in the performance. Next, we check liquidity and transparency of the fund. If performance is good, everything will end up well. Other than performance, transparency and liquidity are important. When we called for redemption of part of funds at the end of last year, some of them were redeemed within one month. But funds with less liquidity were redeemed over the course of six months, so we could not do rebalancing smoothly.”

“Liquidity is important. In investing in hedge funds, communications with the GP is the most important. Although they achieve high returns, if we do not know where they earn the returns, we may not know where they lose money when they swing to losses. If so, it is not easy to invest (in them). When we pick funds, we will put priority on the two factors.”

▶MMAA: “We do not have internal restrictions or regulations. But we check the consistency between what hedge funds spoke of and what they actually invested. There could be an emerging manager that yields decent returns, albeit small. David Swensen also incubated and grew a fund. I envy his insight which seems to make today’s Yale endowment. It is impossible for us to do it because of lack of experience. When it comes to an LP running hedge funds, we will make the best of it in consideration of those things.”

▶KTCU: “We do not have any restrictions on the size of assets under managements (of hedge funds), when we invest in hedge funds. For PEFs, we had required them to have a certain size (of assets). Regarding hedge funds, we think it would be helpful to have a big size. But with regard to those with a short history, we are worrying that there might be a black mark in quantitative assessment. When we increase the volume of hedge fund investments in future, we may set up a small- to medium-sized (fund) segment as did the NPS and KIC. We are now studying it.”

“The important factors for a fund selection are similar to those of Kyobo. We prioritize performance and transparency. We may not know everything about hedge funds. When they yield good returns, everything can be accepted. But if not, we have to ascertain where they did a poor job. That’s why transparency is important.”

▶Moderator: “In the uncertain environment, do you think smart beta or liquid alternative can be the surest road? Have you invested in it, or if you do not intend to do so, what is the reason?”

▶Kyobo: “Frankly speaking, we are little interested in it. We are not thinking about smart beta and liquid alternative. The reason is that our hedge fund book is not big enough. So we cannot separate hedge funds into a kind of an investment asset class. We are approaching (hedge funds) as a high-yielding product. We will not think about it (smart beta or liquid alternative) until before our exposure to hedge funds becomes big enough.”

▶MMAA: “Regarding smart beta, there has been great progress made in the academia and the relevant industry. With the IT development, it has become easier and simpler to implement it. Personally, I prefer a smart beta strategy to a rough alpha (strategy). Regarding liquid alternative, we have to think if liquid is necessarily good. We also have to think if a short-term hedge fund is good. In employing a strategy, we earn a liquid alternative at the cost of a liquidity premium. There are pros and cons, so we may employ it, in line with each strategy.”

▶KCTU: “We are in a similar stance to Kyobo. We do not think they are a new asset class. We may review them as a separate product, but not categorize them in a new asset class separately. In order to boost long-term yields, we will study investment in assets other than smart beta or liquid alternative aggressively.”

▶Moderator: “You are seeing that it is early to adopt a smart beta or liquid alternative (strategy). Korean investors have been making a cautious approach to hedge funds since the global financial crisis. Major pension funds such as NPS are expected to gradually increase hedge fund investments. In 2016, NPS announced that it will invest $869 million in global hedge funds. Do you think NPS will play a role as the catalyst to boost hedge fund investments?

▶MMAA: “Once the NPS implements investment in hedge funds, leading global hedge funds will come to Korea with interest. It will provide small- to medium-sized pension funds with an opportunity to meet top hedge funds. Although such an opportunity may come up, if we are not prepared, it will disappear. We are guessing the NPS will make a thorough preparation. Small-to medium-sized pension funds also have to study hard and make a preparation.”

▶KCTU: “I have a similar opinion. KIC has been the most active in hedge fund investments. KIC has strong track records and made decent returns. If the NPS joins, latecomers like us will get help. But the recent performance of hedge funds was not very attractive. It would not be easy to increase our assets (in hedge funds) aggressively. The pace of growth, taking a certain portion of our 27 trillion (won of assets), will not be fast. We expect the NPS will become a catalyst to the market itself.”

▶Kyobo: “We feel at ease on the fact that pension funds, KIC and the like are investing not only in hedge funds, but also in overseas investments. It helps us make a decision to have domestic investors out there. It also helps us with reference checks. We can grab an opportunity to meet hedge fund managers who we could not have met, if pension funds had not invested in hedge funds or chased only big-size investments.”