[Interview] S.Korea military fund set to invest in offshore blind VC funds from 2017

The Military Mutual Aid Association (MMAA), South Korea’s $8 billion military savings fund, is planning to invest in offshore blind-pool venture capital funds from next year, said its chief investment officer, with an eye to securing decent returns from China’s growing information and technology sectors.

Sang-ho Lee, the CIO of the MMAA, became interested in foreign venture capital (VC) investments after he met Chinese VC officials who had earned hefty returns from investments in two Chinese technology firms - Huawei and Xiaomi – at the ASK Summit hosted by the Korea Economic Daily last year.

“Since then, we exchanged opinions on progress Chinese IT companies such as Alibaba and Tencent made,” he told the Korea Economic Daily in a recent interview. “We will include investments in offshore VC blind funds in next year’s business plan... We plan to invest in PE and VC blind funds on a regular basis every year.”

Lee added that the amount of initial investments in VC funds would not be significant, given that it is still in the stage of studying.

For other types of overseas investments, the MMAA is “seriously considering” investments in infrastructure-investing private debt funds and real estate-related bonds, while raising its exposure to emerging stock markets such as Vietnam and India.

The savings fund for military service personnel and associated civilian employees is aiming to boost the proportion of overseas investments from the current 28% of its portfolio, in an effort to make up for broad-based falling returns. In 2015, it committed 500 billion won ($430 million), or 60% of the 800 billion won allotted for new alternative investments, to overseas assets.

MMAA is South Korea’s second-biggest savings fund by assets after the Korean Teachers’ Credit Union, and oversees 9.5 trillion won ($8.1 billion) in assets, contributed by 166,500 members.

Indicating a cautious approach the fund takes towards overseas investments, however, Lee said that the MMAA prefers senior collateralized loans and mezzanine lending to equity investments. With regard to private equity funds in which t
he savings fund started investing from two years ago, it will continue to invest principally in secondary funds for the next three years.

Lee had worked for Shinhan Bank for about 30 years, holding key posts at the domestic lender including a senior financial planning manager and a corporate financing team head. He also served as a vice president of the bank overseeing risk management, before named as the chief financial officer of the MMAA in 2014. He took over as the CIO in January, 2015. Lee graduated from Korea University’s department of statistics in 1983.



The following are Q&As with Lee.

Q: Please tell us your asset allocation plans and factors you take note of for second-half investments

A: “By the year’s end, we will have stocks and bonds make up 14%, respectively, and alternative investments account for 72%. Regarding the proportion of overseas investments, we are aiming for 28%, which will break down to stocks with 3%, bonds with 10% and alternative investments with 15%. Within the next few years, we will pull the proportion of overseas investments up to 30%.”

“Across the board, investment returns have been declining, so we cannot help but raising the proportion of overseas investments. We will allot 10% to ELS, and the balance to other asset classes such as offshore bonds and M&A financing through structured bonds or in the form of funds. We are keeping a close watch of global oil price movements and a possible U.S. interest rate rise. Although we don’t hold assets directly in Britain, the Brexit possibility is another factor we have to take note of in making a new investment.”

Q: Please tell us the latest overseas investment you made, and your investment principles

A: “Because our association owes our members money that we have to return, we prefer assets generating steady cash-flows. At the end of last year, we had invested in an offshore private debt fund investing mainly in the U.S. in which the economy is relatively in a better position. As real estate prices rose across the board, we also have invested in funds that lend to property, which carries less risks than directly investing in property.”

“Earlier this year, we had invested in a number of private equity funds in the form of secondary funds. Our principle is that we will invest mostly in secondary funds for the next three years. We will build vintages first and once redemptions begin, we can also invest in primary funds. When the PEFs in which we had initially invested through secondary transactions from two years ago enter their fifth year, we can start to cash them in. Then, we may be able to invest in primary ones.”

Q: Any plan to make an additional investment in blind PEF and venture capital funds?

A: “We had invested in secondary domestic PEFs, and now we are studying investing in blind funds of real estate and credit (bonds). As part of portfolio diversification, we are considering investing in offshore venture capital funds from next year. We have been steadily investing in domestic PEFs and VCs, and also we are investing in offshore PEFs.”

Q: Offshore VC is a new investment area for MMAA

A: “At the ASK Global Summit of the Korea Economic Daily last year, we met Chinese VC officials who made great returns from investments in Huawei and Xiaomi. Since then we exchanged opinions on progress in Chinese IT companies such as Alibaba and Tencent made. We will include investment in offshore VC blind funds in next year’s business plans. Because we are in the stage of studying, the initial investment amount will not be big. We plan to invest in PE and VC blind funds on a regular basis every year. Its merit is that asset management companies know MMAA’s plans ahead and can make a preparation in that regard in advance.”

Q: On domestic institutions’ growing interest in Europe’s infrastructure assets

A: “Because of various capital regulations such as the Volcker Rule in the U.S. and IFRS and Basel III in Europe, refinancing of existing loans are becoming an opportunity to Korean investors. We are now seriously considering investing in private debt funds related to infrastructure and real estate-related bonds. When asset management companies bring such investment proposals, many other domestic savings funds come along these days (laughing).”

“Primarily, they are investment opportunities verified by European financial institutions, so we are studying them positively. We recently decided to commit 50 billion won to a global infrastructure PDF run by Brookfield. Our view is that it has specialty not only in the U.S., Europe and Australia, but also in South America.”

Q: What is your favorite investment types?

A: “Senior collateralized loans, mezzanine (lending), etc. Equity investments seem to carry high risks. Previously, we had pursued an over 7% annual internal rate of return. But now we are turning our eyes to assets with expected returns of 5~6%. Normally, we are zooming in on investment cases in which senior loans and mezzanine (loans) are mixed.”

Q: Any particular investment case you made recently?

A: “We invested in an airplane and an asset which has had a lease contract. In our previous investment we did alone, when legal problems occurred, it cost heavily. Thus, we prefer joint investments with local institutions.”

Q: MMAA is known to have specialty in structured bond investments

A: “From three to four years ago, we started investing in them ahead of other domestic savings funds, and they have been yielding high returns. The merit of structured funds is that they guarantee the principal and even if interest incomes turn zero in the short term, they can be offset over a longer term. If a rate rise in the U.S. materializes, we are willing to invest more with a focus on highly-rated bonds.”

Q: On Indian and Vietnam stock markets which MMAA has already been investing in

A: “Because South Korean stock markets have been stagnating in a boxed range in the past four years, it is difficult to make a profit from them. India and Vietnam are promising countries, emulating the rapid growth Korea had experienced in the 1970s. Their stock markets are now in the correction after a bull run. In Vietnam in which we think the (market) correction has ended, we have recently increased our investment. Regarding India, it seems to stay in the recovery stage. Although there is political instability in India, it has a high potential enough to attract tens of billion dollars of investment promises from the U.S., China and Japan. The low average age is another merit of India.”

Q: How about stock markets in Japan and China?

A: “It seems difficult for Japan to continue to keep the yen weak. The majority view is that the Abenomics has reached a limit. We will reduce our exposure (to Japan). On Chinese stocks we hold, we are rebalancing them. We will cut the number of funds which we have been committed to, and will find a fund which is good at long/short strategy to make an additional investment. Even if a crisis happens, we think that IT and transportation sectors will not run out of steam. We are looking for a fund that makes a long-term investment in those sectors and also makes a good use of short-selling strategy on traditional industries which is set to undergo restructuring.”

Q: Any promising sectors for overseas stock investments?

A: “Domestic demand-oriented, consumer sectors would not be bad, if you take a long-term approach. We should pick stocks, taking account of the fact that the Chinese, who eat oily food and drink hot tea, now began to eat western dessert and drink coffee and cold beverages. That change, which had happened earlier in Japan and Korea, indicates that the taste of China’s younger generation is changing.”

“Considering the Veblen’s (conspicuous) consumption in which they drink expensive drinks compared to incomes and post pictures on SNS, if we find suitable stocks and invest in them, we may be able to expect a 10% level of annual returns.”

Q: On your investment strategy for overseas property

A: “Office buildings in suburban areas in the U.S. and other developed markets are our top priority. Core property prices have gone up too sharply. Even if we invest now, if the U.S. interest rates rise, there could be a problem with prices. Chinese capital has driven U.S. property prices higher so far, but the unstable dollar/yuan rate would make it difficult for China to continue to invest in the U.S. property market. That means domestic institutions would find it difficult to profit from (property) transactions.”

“We prefer an office building having a long-term lease contract with a local major company there. Considering taxes to be incurred from a transaction, returns must be at the level of at least 7%. But it is difficult to find such a target. As an alternative, we will find locally-specialized property funds and invest in them.”

Q: On your plan to increase the proportion of overseas investments

A: “We have set a plan to raise (the proportion) to 30%. On equities, we cannot help but going abroad gradually. On bonds, we can say that almost all of them should be comprised of overseas investments. We cannot meet our expected returns with domestic bonds. We, MMAA, had turned our eyes to overseas bonds earlier, which are making a 5%-level return a year. Recently, investments in equity-linked securities (ELS) by domestic financial institutions have been at the center of a controversy. But the ELS we had invested are being managed on a stable basis. The investment we made last year is expected to deliver an annual return of the 8% level, if we hold it until its maturity of three years.”

“On alternative investments as a whole, the amount of overseas investments exceeded that of domestic ones in terms of new investments made since last year. Of the 300 billion won of a net increase in alternative investments last year, we committed 200 billion won overseas. Adding up re-investments of redemptions, of a total of 800 billion won, we committed about 500 billion won overseas. In the case of deals we are studying now, the overseas cases far exceed domestic ones, so the proportion of overseas alternative investments will continue to increase gradually.”

Q: On Korean institutions’ cautious steps recently on concerns about possible global shock

A: “We see strong chances of a China-led shock. But it is difficult to predict when it will happen because the Chinese government may come up with measures. In view of them, we will diversify our investments as much as we can. But we do not worry too much, given that MMAA is not highly exposed to emerging markets. Mostly, we have invested in infrastructure which is less vulnerable to shocks. Also, infrastructure itself is used as collateral, so there won’t be any significant danger.”

“In order to beef up risk management within the MMAA, we recently added many internal layers such as a working-level review, an investment review committee, presentation to the board, etc. It means we will be in a “longer waiting state” right before implementing an investment, while monitoring market situation.”

Q: How about investments in real assets, hedge funds, etc.?

A: “We had invested in derivative-linked securities, but it didn’t lead to high returns. Also, our previous investment in a hedge fund didn’t turn out well. We had invested in a global top 10 hedge fund, but we got a lesson from the investment: “there is no eternal winner in capital markets. We may commit capital to hedge funds again in future. Some hedge funds may have strong capability for bouncing back from sliding markets. Earlier this year, global hedge funds turned bearish all together. But we will monitor their monthly performance and draw up an investment plan.”

Q: Your investment guidance on stock markets?

A: “To make a profit, we are reducing domestic stock portfolios and diverting them overseas on a steady basis. But we cannot stop investing in domestic stocks. We are weighing timing, monitoring market fluctuations. Returns from domestic stock portfolios were okay in the first quarter thanks to the effects of portfolio adjustment last year. The second quarter was not bad. If the domestic (stock) indices tumble, we may turn to ETF investments. But we are not considering it at the moment. We are now investing in ETFs for overseas stocks only.”

Q: What is at the top of your considerations when selecting GPs?

A: “We take note of volatility-related indicators, rather than absolute rates of returns. A wider gap between profits and losses may signal that losses can deepen if a crisis happens. We had eliminated an asset management company in the final round despite its high gross rate of returns, because of high volatility. By contrast, a fund, on which we are about to make an investment decision, received high scores because it made up for losses from the tumbling stock markets early this year by investing in real assets and gold. If an asset management company has capability to reduce losses through strategic asset diversification even in sliding markets, and has investment capability for not only stocks but also real assets, they will be always welcome.”

Q: How about domestic M&A financing sectors?

A: “It will be on a deal-by-deal basis. Companies that would rise to the top after restructuring are always at the top of our investment targets. If it is a decent company in terms of ranking in the industry, viability post restructuring and growth potential, we can invest in them.”

Q: On your announced plan last year to chase M&A deals as a strategic investor

A: “The recently-established investment strategic team within the MMAA takes charge of M&A deals. Recently, we came close to acquiring a company, but it fell through because of price differences. We had said we would enter the (M&A) market of private military companies, but it is difficult to find M&A targets. If the company has a size of 50 billion to 100 billion won in annual sales, competes for first place in a niche market and owns a business model of military supplies, we are willing to acquire it.”

By Dae-hun Kim daepun@hankyung.com