Research Staff

Research Staff




Pre-approval for Qualified Default Options and Role of Financial Institutions / Feb. 21, 2023
Korea’s default option pre-designation has been introduced as a selective default option system to the existing retirement pension scheme. It can be understood as a system similar to the representative product designation that requires retirement pension plan providers to offer low-cost, high-efficiency products to support DC plan or IRP holders in their product selection. The Ministry of Employment and Labor pre-approves up to ten representative products for each provider. After employees pre-designate a product suitable for their risk appetite, the products can function as an opt-out default option. Given that default options can be managed for a long term without any investment instruction, financial institutions or providers of default option products should take seriously their fiduciary duty to act in the best interest of employees. The fiduciary duty needs to be considered from the first stage of the default option scheme including product design and qualified default option pre-approval. In an analysis of 259 qualified products approved by the Ministry of Employment and Labor, most of them seem to fulfill requirements including low fees and stable returns. It is notable that various products including the principal-protected type take the form of a fund of funds (FoF), not a single deposit or fund. In the process of building a default option portfolio with a mix of subfunds, it is necessary to underscore the importance of risk diversification, a prerequisite for plan asset management. What is also needed is to provide default options fit for individual risk appetites based on the suitability principle. It becomes commonplace globally to use TDFs in default option composition but TDFs are inaccurate and inconvenient to establish an FoF that deals with a non-variable level of risk. A target risk fund (TRF), one type of balanced fund (BF), is more appropriate for the FoF composition. As for TDFs, it is advisable to use a single TDF that represents a target date corresponding to individual risk appetites. Recently, FoFs consisting of TDFs increasingly serve as a typical default option, which raises serious concerns.The default option scheme represents both heavy liabilities and great opportunities for financial institutions. In terms of risks and returns, the capability of designing and providing qualified products can serve as the most critical competitive edge for financial institutions in Korea’s pension market that lacks healthy competition. This suggests that the key to the success of default options lies in building the trust of employees in long-term investment.
Long-Term Projection of Korea’s National Pension Fund and Reform of Fund Management System / Sep. 06, 2022
Korea is on the threshold of a new era of the KRW 1,000 trillion National Pension Fund (NPF). The current NPF management system was designed in 2005 when pension assets worth KRW 160 trillion were invested primarily in domestic bonds. This giant asset size of KRW 1,000 trillion requires a qualitative change to sophisticated portfolios and investment strategies, rather than quantitative growth. In this respect, the NPF has devised a long-term management strategy that aims at building a diversified global investment portfolio by increasing the weight of alternative investments and reducing home biases. But it has made little progress in implementing the strategy. The key to advanced fund management lies in an efficient decision-making system and a competent management entity. The existing NPF Management Committee consisting of representatives is regarded as a decision-making structure unfit for advanced asset management, while the management entity under the National Pension Service (NPS) exposes limitations that make it difficult to implement strategic decision making. The reforms of foreign public pension funds imply that the desirable governance for public pension funds necessitates a top decision-making body run by a group of experts and an independent management entity. The issues arising from the proposed governance, such as government accountability and the connection between the pension scheme and fund management, could be addressed through the enhanced Asset Liability Management (ALM). If the function of the ALM Committee is assigned to the National Pension Operation Committee, it would be possible to bolster the ties between fund management and pension operation and hold accountable the government as the last resort of pension benefits payment. In line with the NPF governance reform, it is worth considering reorganizing the management entity into a dedicated fund management entity with an independent board of executive officers.In the run-up to the fifth actuarial valuation of the NPS scheduled for 2023, discussions are underway on the pension scheme reform and the fund management system reorganization. The institutional reform aiming for the national pension scheme’s long-term financial stability should be examined alongside efficient fund management. Notably, the increase in investment returns could have a significant impact on financial stability and efficient fund management is an essential precondition for reaching a social consensus over a pension reform that may put pension holders at a disadvantage. Korea is now at a critical juncture to discuss how to reform the pension fund management system to enhance stable and long-term investment returns.
Korea’s Target Date Fund (TDF) Market: Current Status and Improvements / Mar. 08, 2022
Korea has a great expectation that the introduction of default options to the retirement pension scheme would boost the growth of the Target Date Fund (TDF) market. The management structure of TDFs with a life cycle-based portfolio rebalancing mechanism best suits the implementation of default options. Such growth of the TDF market has been similarly observed in the US and other economies with a developed default option scheme. Korea has seen its TDF market post a two-fold increase every year since 2016, a growth trend that is expected to accelerate after default options are fully adopted. Given the characteristics of the default option scheme and TDFs, herding towards the top major funds is likely to intensify in Korea, as is the case with the US. Under the circumstances, what is needed are specific standards for establishing a default option, regulations of pension asset management, and the reinforced disclosure system. In the Korean version of the default option scheme, healthy competition in the market is essential for TDFs to act as a critical tool for pension asset management. To this end, ordinary employees should be able to conduct an objective comparison between various investment products that are offered in the form of default options. As for a TDF that is the fund of funds, it is important for pension providers to disclose glide path-related information and details of sub-funds incorporated for realizing the glide path. Such disclosure makes it possible to fully take into account Korea’s employment conditions and household asset portfolios that are quite different from those of the US. In this respect, Korea’s pension providers should develop their own TDFs or actively customize the TDFs imported from overseas markets.
Reference Portfolio in Public Fund Asset Allocation: Significance and Implications / Sep. 28, 2021
A reference portfolio refers to a low-cost, passive portfolio designed to express a fund’s risk appetite. It typically consists of risk assets and safe assets. Recently, the National Pension Service Investment Management has been considering a shift from the existing two-phase asset allocation mechanism comprised of Strategic Asset Allocation (SAA) and Tactical Asset Allocation (TAA) towards a three-phase framework with a reference portfolio serving as a norm. Such a move to introduce a reference portfolio can offer implications for Korea’s other public funds in varying sizes that have adopted an asset allocation framework similar to that of the National Pension Service Investment Management.In terms of fund management, a SAA is the most important investment decision making. SAA-related activities are not limited to allotting a target weight to a certain asset class. They should be understood as the overall asset management process ranging from defining asset classes based on exploration of sources of market returns (β) to setting out a benchmark that defines the market and determining optimal asset weights. When the SAA is recognized as a sophisticated investment decision and the overall investment process, whether SAA activities are appropriate should be subject to ex-post evaluation and reflected in asset management practices. In this evaluation, a reference portfolio can serve as criteria for gauging the properness of a SAA.For effective fund management governance, those who make investment decisions are required to take direct responsibility for the consequences of their decisions. The same is true for the determination of a SAA—the investment decision of utmost importance in terms of fund management. In this regard, it is desirable to ensure that the fund management team assumes the role and responsibilities with regard to implementation of SAA activities. This means a three-phase asset allocation framework where the fund management committee is responsible for the reference portfolio establishment while all sub-category asset allocation activities including a SAA are primarily dealt with by the fund management team. Such reform in the asset allocation system can be applicable to Korea’s public funds being operated by OCIO as well as the National Pension Service. An essential prerequisite for effective operation of the reference portfolio framework is improvement in the performance review system of the fund management team. Also necessary is to expand the fund management team’s expertise and capabilities in asset allocation.

Seminar Presentation