KIC, NPS to boost customized hedge fund investments

South Korea's sovereign wealth fund, Korea Investment Corp. (KIC), and the National Pension Service are looking to boost hedge fund investment through customized products such as separately managed accounts (SMAs), while the Government Employees Pension Service (GEPS) is avoiding quantitative funds due to their poor performance and a lack of communication, said their senior investment managers.

Reduced market volatility and crowded hedge fund positions given fierce competition have raised the importance of the selection of managers to which the South Korean asset owners are calling for enhanced transparency and frequent information sharing.

“We had invested mainly in co-mingled funds, but we are now considering investing in customized products through SMAs and the funds that fit KIC’s risk/return profile,” KIC’s senior investment manager Huh Yoon told a Hedge Fund & Multi Asset Real Estate Infrastructure panel at the ASK Summit 2020. It was hosted by The Korea Economic Daily in Seoul Oct. 28.  

“By investing via SMAs, we will be able to cut fees and improve information transparency in them,” said Huh, adding that fund liquidity, transparency and ESG themes are other factors to consider.

NPS’ general portfolio manager Kim Jun-geun also called on hedge fund managers to meet its customization needs, saying that the $690 billion state pension fund is trying to make creative investments with its hedge fund strategies. He is one of the two officials handling the hedge fund portfolio at the world’s third-biggest pension fund.

Lee Jin-young, head of GEPS’ alternative investment team, said that the $8 billion pension fund is cautious about sharply raising exposure to hedge funds, given the relatively low expected returns. In particular, she criticized quant fund managers' reluctance to share information with investors.

“It is hard to even get an interview with them (quant fund managers). From the perspective of investors, we wonder if we need to put up with it,” she said.

Korea Post’s alternative investment division’s Deputy Director Park Sehoon said that its savings unit with $72 billion in assets plans to add new hedge fund managers to its pool, calling for frequent information sharing.

While the NPS is keen on credit-related strategies, Korea Post is interested in equity-related positions, including strategies that reflect macroeconomic conditions.

The following are key remarks from the four institutions' hedge fund managers at the ASK Summit 2020:    

REVIEW OF 2020 INVESTMENT, MID- TO LONG-TERM MANGEMENT PLANS

▶ NATIONAL PENSION SERVICE SENIOR PORTFOLIO MANAGER KIM JUN-GEUN:

“NPS began hedge fund investment in 2016. We have mandated five single-manager hedge funds and two funds of hedge funds. We hired Albourne as a portfolio advisor and MSCI Inc. as our risk aggregator.”

“Markets have stabilized considerably after experiencing severe volatility in March. But returns from our hedge fund portfolio have not been satisfactory since we began investing in them in 2016. We are in the portfolio building stages.”

“Long-only funds have benefited substantially from low interest rates, but I doubt whether governments will continue to support economies with large-scale stimulus packages. We need to brace for downside risks and take into account such signals.”

“NPS is growing and in the accumulation phase, so we prefer long-term investment. Despite hedge funds’ short duration strategy, they are attractive strategy as a liquid alternative asset class because we need to prepare for the period when our fund enters a downsizing period in seven to eight years.”

“For now, we put on hold distressed strategy of which valuations look high. Instead, we are looking at credit-related strategies given their attractive valuations.”

▶ KOREA INVESTMENT CORPORATION SENIOR INVESTMENT MANAGER HUH YOON H:

“KIC began hedge fund investment in 2010. Since then, we expanded hedge fund investment into single-manager funds for various strategies including equity, event-driven and global macro. Currently, we have mandated $5 billion to dozens of hedge funds. More than half of them are exposed to North America. Six people at KIC are in charge of hedge fund investment. They are generalists in charge of new investment decision and portfolio rebalancing, as well as monitoring the risk of individual funds.”

“We look at hedge funds as part of a portfolio diversification. Considering the low interest rates and low market volatility, market conditions have changed significantly from those days when they earned high single-digit, or over 10% returns. In the first half of this year, we studied the hedge funds’ efficiency as a strategy to respond to market conditions. Going forward, we will continue to rebalance our portfolio, depending on market conditions.”

▶ KOREA POST, POSTAL SAVINGS, DEPUTY DIRECTOR, ALTERNATIVE INVESTMENT DIVISION, PARK SEHOON:

“Given the extreme market volatility in the first quarter, hedge funds produced poor returns across all strategies, not only equity-linked strategy. Some of credit-related strategies, using high leverage, suffered heavy losses, against our expectations for stable returns."

"Nevertheless, they made quick recovery, compared to other asset classes and returned to positive in the second half in terms of cumulative returns for this year. Their attractiveness has increased slightly relative to private equity funds. But I doubt whether they will be able to attract as much money as they did four to five years ago.”

“We will gradually increase exposure to hedge funds, in line with our medium-term plan to increase the portion of alternative investments. By strategy, we are more interested in equity-linked strategies such as long/short and equity market-neutral, than credit-related ones.”

“In the past, credit-related strategies took a higher ratio due to our focus on stable returns. But after going through portfolio rebalancing as part of our efforts to balance our portfolio and raise target returns over the past few years, equity-related strategies take a higher proportion. Additionally, we will expand into macro strategies.” 

▶ GOVERNMENT EMPLOYEES PENSION SERVICE HEAD OF ALTERNATIVE INVESTMENT TEAM LEE JIN-YOUNG:

“Increased market volatility and market dislocations created many investment opportunities for hedge funds. But since the coronavirus outbreak, the performance gap has widened between managers, and now it is more important to select good managers."

"We will select managers that coped well with the market downturns hit by COVID-10. Long/short equity strategy funds based on fundamental factors posted good performance. Long/short credit arbitrage and convertible arbitrage funds also showed good performance. But quant strategies are underperforming in the short to medium term."

"Funds with a highly structured leverage suffered double-digit losses and still are not making up for the losses. Event-driven strategy also is struggling due to dwindling M&A transactions."

“Whether they make high returns depends on manager’s capability, so manager selection is becoming more important. In the medium to long term, it will be hard for them to achieve the high alphas as before as they have a higher correlation with the market. Because of heated competition between managers their positions became more crowded. In the medium to long term, we are cautious about sharply raising exposure to hedge funds.”

CUSTOMIZATION, TRANSPARENCY

▶ NATIONAL PENSION SERVICE:

“These days, global institutional investors put more focus on investment ideas than asset classification. NPS created a new asset class for private equity, private debt and multi-assets under the group name 'other asset class' in 2019. Such so-called mini asset groups are broadening their areas.”

“We try not to make stereotypical investments. We will set up internal platforms carrying out various strategies in several phases of a market cycle. We are making efforts to make creative investments based on ideas, in communication with other pension and sovereign wealth funds. Given the hedge funds’ great variety (in strategies), we are expecting them to produce high returns, depending on the strategy.”

▶ KOREA POST:

“We rebalance portfolios on a quarterly basis. From underperforming funds, we postpone redemptions if they are expected to recover in consideration of the fund’s characteristics and strategy.”

“I have a couple of things to ask asset managers. I hope you to frequently share the fund's strategy and investment cases with investors. The quantitative performance of the past will no longer serve as a guide to future performance. Based on only regular reports and factsheets, it is hard to know and predict which strategy the fund is exactly using and which outcome they will be able to create.”

“It may be because there are more small fund houses (in the hedge fund industry) than other asset classes, and thus they do not have big IR teams. But they don’t have to update us with written documents. Conference calls will be of great help to share your investment strategies with investors.”

▶ KOREA INVESTMENT CORPORATION:

“We had invested mainly in co-mingled funds, but we are now considering investing in customized products through SMAs and the funds that fit KIC’s risk/return profile in consultation with management companies. By investing via SMAs, we will be able to cut fees and improve information transparency in them. We can make thorough monitoring of them on a frequent basis and continue to rebalance our portfolio, in tandem with changing market conditions.”

▶ GOVERNMENT EMPLOYEES PENSION SERVICE:

“There are very famous quant fund managers and quant funds used to show outstanding performance. We included quant funds in our portfolio. But since the coronavirus outbreak, quant strategy funds have been underperforming markets, compared to other strategies.”

“Such algorithm-based quant strategies, minimizing human intervention, seem to have reached their limit under the current market conditions. Given the current market conditions, we may need to be wary of depending entirely on technology, without human judgment.”

“In particular, most quant fund managers maintain strict confidentiality over their investment details, compared to other strategy fund managers. It is hard to even get an interview the fund managers. From the perspective of investors, we wonder if we need to put up with it.”

“But given the quant strategy is evolving in line with the AI and machine learning development, the quant strategy will likely take a bigger role within the hedge fund industry. We will continue to be interested in quant strategy.”

FACTORS TO WATCH TO SELECT HEDGE FUND MANAGERS

▶ NATIONAL PENSION SERVICE:

“Asset managers tend to allocate less resources to Korean and Asian investors in general, compared to European investors. Our needs and the quality of service we expect from them are not different from those by European investors. To maintain long-term relationships, such soft aspects are important, say, customizing investors’ needs. For example, when we gather information through our risk aggregator Albourne, some GPs refuse to get operational due diligence. The funds that satisfy our customization requirements will have good, long-lasting relationships with us.”

▶ KOREA IVESTMENT CORP:

“We select new GPs through a competitive bidding process, based on our annual investment plans set out at the end of the previous year. We make the selection based on information database, but we can add hedge funds which we have kept track of to our list. If they build networks with our officials in charge, it would be helpful, although those with excellent qualifications in terms of returns have a high chance of being selected.”

“Given the size of our investment, a fund with a certain size has a high chance of being selected. What is the most important factor is a track record because risk and return data is the most objective criterion. These days, fees and fund liquidity are becoming important, following track record. In particular, lowered expected returns from hedge funds will make it difficult for funds with a high fee structure to generate high returns. As a public institution, KIC cannot help but take into account fees. Fund’s liquidity, transparency and ESG factors will become more important.”

▶ KOREA POST:

“First of all, we look closely at returns and volatility factors. Now we are trying to have a forward-looking perspective on those factors to get new asset managers included in our pool. We used to focus on the past performance, but now we are trying to concentrate on their latest performance for which new asset managers could outdo established firms.”

“Small asset managers, if they have qualifications and excellent strategies, can manage institutional investors’ money. But given the financial incidents involving small asset managers in the past, we will look closely at how transparently they share information on investment status and performance. We do not mean how quickly they will keep us updated about investment performance, but how detailed information they will provide to us about investment status. In that context, we think funds winning transparency and ODD (operational due diligence) ratings from global research firms as safe funds.”

“Additionally, we look closely at the redemption conditions and liquidity conditions of a fund, because we put focus on the possibility of a fund recovery in emergency.”

▶ GOVERNMENT EMPLOYEES PENSION SERVICE:

“We put a big focus on the fund’s performance and risks, so we work with asset managers with AUM of a certain size and track record. We look closely at how many illiquid assets they have and their redemption conditions, compared to their peer groups’. In particular, we put a big focus on their operational risks, because they still do not disclose details of their portfolios. We use specialized firms’ reports about operational risks and invest in a fund having earned a certain rating or above. Once we invest in them, we have our FoF managers visit them every year.”

“From a long-term perspective, we prefer managers producing stable returns over a longer period rather than those producing high returns in a short period of time. We also look at how well they coped with market downturns and prefer an institution with low volatility in performance.”

Yeonhee Kim edited this article.