Cashed-up NPS continued its shopping spree with the purchase of the 41-story Aurora Place office tower overlooking Australia’s Sydney Harbor, followed by the acquisition of a 12% ($160 million) stake in London Gatwick Airport, the second-largest airport in the UK. Currently, the NPS portfolio also includes office buildings in prime districts in Tokyo, London and Sydney, while it is also eyeing locations in New York. 

The aggressive play to invest up to $3 billion in international real estate could appear questionable from a risk prudence standpoint, but there is solid reasoning behind the move. Asian investors, including sovereign wealth funds such as the China Investment Corporation (CIC) and Qatar Holding LLC, have been making similar purchases, believing there is a unique opportunity to enter these markets at attractive prices. 

Yet, the NPS move is based on more than just an eye for a bargain. It is inspired by fundamental changes to the organization’s own structure and investment strategy. In recent years, the fund has sought a solution to resolve the chronic asset/liability mismatch that has plagued it since its inception in 1988 and to manage the rapidly growing pension assets more efficiently. 

One of the main concerns driving the change is the need to push back the date when pension assets will be exhausted so as to better cope with the dramatic demographic changes confronting South Korea. While the proportion of elderly people in South Korea is currently the second-lowest in the Organisation for Economic Co-operation and Development (OECD), it will be amongst the highest in 2050 (see A Country for Old Men). To meet the demands of the rapidly graying society, the fund needs to enhance returns through effective diversification in overseas asset classes including equities and fixed income securities, real estate and private equity. 

A revised Pensions Bill passed by the National Assembly in 2007 enabled the NPS to correct the yawning discrepancy between generous benefits and low contribution rates. In addition, the age for benefit entitlement will be raised from 60 by one year every five years until it reaches 65. Prior to this reform, the pension assets were expected to be exhausted by 2047, but these measures should now extend the timeline until 2060.

THE ABILITY OF THE NPS to adopt an aggressive approach so soon after the global financial crisis is the result of a portfolio that was heavily tilted toward domestic fixed-income securities. While the fund had averaged 6.2% from its inception, it only recorded a performance of -0.18% during 2008 at the height of the crisis, a solid return considering the carnage that reigned in the markets. In 2009, the fund is expected to record its highest performance in 10 years. 

Following the changes, the NPS has become more willing to embrace risk. Equity investment increased to 15.8% in the second half of 2009 from 11.7% in 2006, while the overseas equity investment increased to 3% from 0.7%. 

With NPS assets growing at an increasing pace, the asset allocation strategy is becoming more important. Pension assets are expected to exceed KRW300 trillion ($258 billion) this year, according to the NPS, and peak at KRW2,500 trillion ($2.15 trillion) in 2043. Given the size of the fund, some experts are worried that the NPS could distort the Korean financial market. Lee Joon-Haeng, a professor at Seoul Women’s University and chairwoman of the Korean Derivatives Association, has proposed splitting assets into several sub-funds as a more effective method to manage and monitor the assets than a single jumbo-sized portfolio. 

According to Dr. Jun Kwang-Woo, chairman of the NPS, the organization aims to expand overseas investment from 10% of its $240 billion portfolio to 25% of its projected $400 billion by 2014. Dr. Jun was previously chairman of Deloitte Korea, chief economist at the International Bank for Reconstruction and Development and a former governor at the Financial Supervisory Service in Korea. 

In terms of domestic equity investment, the NPS currently holds a 4% stake of the total Korean stock market and this is expected to reach 10% within five years. Dr. Jun says that it would be natural for the fund, as a major shareholder, to take a greater role in enforcing corporate governance and protecting shareholders’ value. According to Dr. Jun, the NPS is also considering investment in energy, such as raw materials and renewable energy, this year. The NPS could either form a consortium or directly invest in target companies.

THE PURSUIT OF RISKIER investments to generate higher returns needs to be counterbalanced by a greater emphasis on risk management, believes Professor Lee. She acknowledges that recent NPS investments in infrastructure and commercial buildings seem good alternatives to domestic equities and fixed income securities due to their low correlations. 

Lee Jae-Kwang, research head of Korea Investment and a member of an advisory committee to the NPS, recently stated that the NPS had previously been hamstrung in its pursuit of long-term stability while generating maximum return at a given risk level by an extremely conservative investment approach that concentrated on domestic fixed-income securities. Given that the changes have resulted in an increasingly active management style, the global financial community is likely to be reading more about the NPS in the years ahead.   

Yet, the structural change within the NPS is not yet complete. The NPS needs to strengthen control procedures and attract more talented professionals. The number of portfolio managers at the NPS currently totals 120, which implies a challenging average of KRW2.2 trillion ($2.1 billion) in assets per portfolio manager.  

Speaking recently, Dr. Jun said he is seeking cooperation with politicians and government officials to attract more talent to the organization. Han Dongju, a portfolio manager at the NPS, agrees the plan to attract more talent and enhance the professional competitiveness of existing managers makes sense. It is unrealistic and inefficient, he says, to entirely rely on internal capabilities to nurture the investment expertise necessary for the NPS in the challenging years ahead.

Published by PROJECT M in April 2010

(Photo: Laif/Ludovic Maisant)