Already 10 years ago, predictions were made that Korean investors would turn massively to alternative investments.
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Since then, Korean asset owners have indeed shown a deep interest and ability to diversify their portfolio into alternatives – more so than their Asian peers. Above all, pension funds and self-help associations have allocated a considerable part of their capital to private market assets on a global scale.
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While the wave of alternatives is likely to continue, there could be indications that demand could be dampened in upcoming investment calls from Korean pension funds and self-help associations for several reasons.
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As mentioned, some Korean pension funds and self-help associations have already invested a relatively high share of their portfolio in alternatives. From a risk and diversification perspective, there is a limit to the level of exposure that is considered sensible.
As interest rates continue to rise in the US in particular, Korean investors will likely wonder whether fixed income securities will regain the attractive risk/reward profile they once had, with or without hedging costs. Compared to the alternatives, fixed income securities and government bonds offer the certainty of return that any pension fund will seek for its members.
The challenge for alternatives remains the lack of mark-to-market valuation, especially at a time when global and regional uncertainties could tip economic and financial odds in the future. In volatile markets, transparency and familiarity will have increased appeal.
Sources familiar with the thinking of Korean pension fund investment managers and self-help associations tell Asian investor that a tendency to stick mainly to known alternative investments could become widespread. For example, investors will likely allocate their preferred investments by replenishing combined fund mandates or allocating capital to subsequent platforms within the same series of proven funds.
In terms of diversification, Korean pension funds and self-help associations are expected to show increased interest in multi-asset class investments to increase the diversification of an overall portfolio through an asset manager, instead of from several different managers. Asset managers offering such multi-asset solutions are expected to attract more interest from some Korean investors.
THE ENIGMA OF CURRENCY
On August 30, 2021, one US dollar cost 1,165.51 Korean won. On August 30, 2022, that same US dollar cost 1,345.21 Korean won, an increase of 15.4%. With the United States being the world’s largest and most sophisticated market for alternatives, the exchange rate brings other considerations for Korean investors.
While some relatively large pension funds or self-help associations invest directly offshore in mixed funds of asset managers, others work with domestic asset managers who then pool capital from multiple owners. assets in a combined mandate. This mandate is then invested in one or spread over several funds or in the direct ownership of assets, such as ownership often traded by Korean securities companies, depending on the strategy.
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In both models, but especially in the last one, currency risk comes into play because the capital is not invested right away. In fact, capital can lie dormant in the form of “dry powder” without being invested for some time, sources explained. Asian investor.
Since private market valuations are less transparent and locked in the long term compared to liquid investments in public markets, there can be a large swing in both the price and the cost of the exchange rate when capital calls are finally made. . And the same problem will arise if the underlying assets have to be sold later.
Currency hedging can of course significantly solve this problem. However, with such a high cost, Korean investors might as well take that cost of hedging into fixed income, where they know risk and return more clearly.
PIGGY BOX FOR PRIVATE HOUSEHOLDS
The private economy of Korean citizens looks likely to be directly and indirectly affected by recent interest rate hikes around the world, including the Bank of Korea’s half-percentage-point hike on July 13.
Although Korean household debt fell to 104.3% of GDP in the first quarter of this year, from 105% in the same period a year earlier, it is the highest level among 36 major economies, according to the Institute of International Finance, an organization based in Washington. private association of the financial sector.
In Korea, individuals can take out a loan from their pension fund or their mutual aid association. These loans have relatively attractive interest rates compared to bank loans or credit card debt. Thus, it is not uncommon for Koreans to repay these loans with a cheaper loan provided by their pension plan.
Although it has not yet reached a critical level, this tendency to lend money to retirement savers is expected to impact liquidity and the amount of dry powder this year for pension funds and associations. mutual aid, according to sources. Asian investor. Relatively little capital to deploy makes investors less likely to venture into new and unfamiliar asset types, but stick to traditional and well-known assets, both in terms of types (equities, income securities fixed) and in alternative investments in particular.
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