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Teachers' Pension CIO pays heed to alternatives valuation

By Oct 21, 2020 (Gmt+09:00)

Alternative asset values have risen to burdensome levels due to strong demand, but the Teachers’ Pension in South Korea will continue to increase alternative investments in search of higher yields via top management companies, said its Chief Investment Officer Lee Kyuhong.

Alternatives make up 21% of the pension fund's 19.5 trillion won ($17 billion) in assets under management as of the end of September. Infrastructure, real estate, and private equity and debt make up one third, respectively.

“Overall, the current valuations on alternative assets look burdensome. Plenty of liquidity is chasing a limited number of targets, pushing their valuations higher,” Lee told The Korea Economic Daily in a recent interview.

“We cannot help but increase the portion of alternative investments despite valuation concerns, given that bond yields are too low.”
Teachers' Pension Chief Investment Officer Lee Kyuhong
Teachers' Pension Chief Investment Officer Lee Kyuhong

Most of the pension scheme’s overseas alternative investments are made through blind pool funds run by global management firms. It will continue to entrust the bulk of global alternative investments to leading global management houses with a proven track record and access to lucrative deals, said Lee, an ex-CEO of Ascendas-Singbridge Korea, a Singapore-based asset manager.

For global equities investment, Teachers’ Pension will begin to directly manage part of its overseas passive stock investments to reduce management fees by several millions of dollars per year.

The CIO, inaugurated in September 2019, expects risk assets such as stocks to find support from the governments’ policy efforts to rejuvenate their economies. But he cautioned that asset managers’ portfolios are heavily weighted towards certain sectors, such as growth stocks tipped to benefit from the non-contact business boom.
Regarding environmental, social and governance (ESG)-themed investment, Lee said he would take a cautious approach to sustainability investment, which is still vulnerable to subjective judgment.

In the first half of this year, the pension fund for South Korea's private school teachers and employees returned 2.49% on investments.

In a May interview, Lee said Teachers' Pension will chase infrastructure facilities and industrial park properties in developed countries for overseas alternative investment, while focusing on e-commerce and daily necessities industries for its equity portfolio.

The following is the full transcript of the interview:

▶ On the pension's robust performance since you took office as CIO last September:

“In line with our medium- to long-term asset allocation strategy, we are gradually reducing our fixed-income portion given low-interest rates. Because of the higher correlation between equities and fixed-income securities, we are increasing the share of alternative investments that have a low correlation with traditional assets.”

“After stock markets tumbled in March hit by the coronavirus pandemic, we began buying in early April despite the gloomy economic outlook and pessimistic views on financial markets. The purchases were in part to stick to our medium- to long-term asset allocation strategy.”

“After stock markets rebounded, we have been reducing stocs gradually since mid-June.”

▶ On the ratio of direct and indirect equities investments:

“Domestic and global investments are divided into two halves. For domestic equities, we entrust 60% of them to outside managers and directly manage the other 40%. For global equities, we entrust 100% to outside managers.”

▶ On diversification in terms of management firms?

“They are well diversified. For global equities, we are revising internal rules to directly manage passive investing. First of all, we will bring part of the existing passive investment entrusted to outside managers back in-house. We will be able to decide by year’s end on how much passive investing we can bring back."

“By bringing passive investing in-house, we are expecting to cut management fees by several billions of won from 2023.”

▶ On hefty returns from global fixed income:

“Despite interest rates remaining low, we can achieve valuation gains when they drop further. The ultra-accommodative monetary policies taken by governments in the wake of the coronavirus outbreak lowered the interest rates even further. The won’s decline (against the dollar) boosted the translated returns. Under the medium- to long-term asset allocation strategy, Teachers’ Pension will not significantly increase its portion of global fixed income.”

▶ On your tactical response through H1, 2021 to the rise in coronavirus-caused uncertainty:

“From the current quarter through the first quarter of next year, risk assets are unlikely to perform badly. Despite the gloomy economic outlook, risk assets such as stock markets have performed well, reflecting major economies’ determination to revive their economies. Given this, it would be unlikely for risk assets to drop sharply for the time being.”

▶ Biggest concern for asset management:

“Many asset managers are weighted towards growth stocks, or those seen to benefit from non-contact business and the fourth industrial revolution. We outsourced investments to balance our portfolio by type, but with the boundaries between the types collapsing, they are heavily weighted towards certain sectors.”     

▶ On alternative investment portion:

“Alternative investments account for 21% of the portfolio. Specifically, domestic alternatives take a 10% share and overseas alternatives at 11%.

“As a whole, infrastructure, real estate and corporate finance account for close to one third, respectively. Equity investments outpace debt investments. They are evenly divided into overseas and domestic portfolios.”

▶ On portfolio management:

“The reference portfolios, used by global sovereign wealth funds and pension funds such as Singapore’s GIC, CalPERS, ABP of the Netherlands and Canada’s CPPIB, are comprised of equities at 60-85% and fixed income at 15-40%. In their actual portfolio management, they include alternative investments to lower risk while securing similar returns to those of their reference portfolios. Basically, it appears that they maintain equities at 60-70% and fixed income at 30-40%.”

▶ On portfolio risk:

"Bonds account for 40% of our portfolio. Including debts categorized into the alternative group, the fixed-income portion is not low at all.”

▶ On alternative asset valuations:

“Overall, the current valuations on alternative assets look burdensome. There is plenty of liquidity chasing a limited number of targets, which pushes their valuations higher. Because of low bond yields, the declining risk-adjusted discount rate pushed asset values higher. Yet, we cannot help but increase the portion of alternative investment despite valuation concerns, given that the bond yields are too low.”

▶ On alternative asset allocation:

“Overall, we will increase the portion of alternatives in our portfolio. According to our medium- to long-term asset allocation strategy, fixed income, equities and alternatives are meant to be divided into a ratio of 3:4:3 by 2024.”

"We will balance our alternative investment between corporate finance, real estate and infrastructure by splitting them into thirds.”  

▶ On details about infrastructure investment targets:

“Power plants, harbors, roads, subways and renewable energy are among them. Last year, we made a relatively big investment in a railway project in the Seoul metropolitan area. But this year, there were not many investible projects. It may be because of the coronavirus impact.”

▶ Which asset managers do you usually mandate for overseas alternative investments?

“We invest mostly through global managers’ blind pool funds because we don’t have enough manpower to directly source deals and conduct due diligence. Most of our allocation goes to top global managers, including Brookfield, Blackstone and Macquarie, who have proven track records. I think management companies with a global brand and strong networks will have relatively more opportunities to access good deals.”

▶ For overseas private equity investment, do you also invest through big-name companies?

“Yes, we do. Most of the foreign PE managers that received mandates from Teachers’ Pension are global frontrunners that posted high rankings in the fundraising league table in the past 10 years.”

▶ Do you prefer fund houses with larger AUM?

“Rather than the AUM size, we look into their track records to see if they have proven management capabilities, in addition to their investment return, history and process. I also review their long-term performances to see how they performed during an economic downturn, whether they have a clear value-up strategy and if the value-up strategy worked in past investments, and if they can be differentiated in deal sourcing.”

“We do not like a management company that sources deals by bidding up in a public tender. Management companies with differentiated global networks and track record have a high chance of securing good deals at an attractive price in separate negotiations.”

▶ Does Teachers’ Pension also invest in real estate through blind pool funds?

“When it comes to overseas investment, yes, we do so for overseas investment.”

▶ Are you on course to meet your goal of raising overseas alternative investment?

“We fell well short of the goal this year, mainly because we could not travel to conduct on-site due diligence in the pandemic situation. In selecting a blind pool fund manager, it would be desirable to conduct due diligence on the management company.”

▶ On funds with 2020 vintage year:

“Given the high valuations, funds with 2018-2020 vintage years may not perform well. But it would be desirable to diversify into several vintage years to balance the portfolio.”

▶ On participation in Stewardship Code:

”Both the Teachers’ Pension andthe  Government Employees Pension Service established seven principles late last year to participate in the (Korean) Stewardship Code and were certified as Stewardship Code participants. We will begin to adopt the Stewardship Code from next year, once relevant internal rules are revised.”

“Regarding ESG factors, global research houses’ ESG assessments vary even for an identical company, meaning they are vulnerable to subjective judgment. Given that, our ESG investing could face a lot of challenges. As a public institution, we are trying hard to fulfill a responsible shareholder role.”

Write to Ri-Ahn Kim and Sang-eun Lucia Lee at

Yeonhee Kim edited this article.

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