Research Staff

Research Staff




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.
DC Plans and Default Investment Options / Mar. 23, 2021
Retirement pensions have a public aspect as they are mandated by the government for the purpose of post-retirement income security amid population ageing. Of the two types of retirement pension plans─defined benefit (DB) and defined contribution (DC), a shift towards DC plans has been a global trend due to DB plans’ increasing financial burden on employers. Korea is expected to see DC plans increasing fast as more and more small- to medium-sized firms are mandated to introduce the retirement pension scheme. However, DC plans require the members to manage their assets for a long investment horizon on their own, which is often pointed to as a structural flaw in terms of the scheme’s initial intention of post-retirement income security. One of the most effective institutional fixes to this problem is a default option. Already, several bills were proposed to introduce the default option in Korea, but the introduction was delayed several times due to concerns about a principal loss. In managing long-term assets such as retirement pension assets, a short-term valuation loss is not an intolerable risk factor. Designing a default option totally without any valuation loss in annual term is contrary to the initial policy intention. The current situation where over 80% of retirement pension assets are repeatedly rolled over into one-year time deposits can be hardly interpreted as reflecting plan members’ rational risk-adverse behavior. More likely, it could have stemmed from the members’ lack of interest and capability for managing their investment. What’s needed now is an institutional tool that first defines tolerable levels of risks across different age groups taking into account the retirement timing, based on which to build a well-diversified investment portfolio. Now, more than ever before, is the time to benchmark best practices in other advanced markets for formulating and introducing an effective default option scheme.
A Thought on Korea’s Growing OCIO Market / Oct. 13, 2020
Korea’s OCIO market usually led by large-scale public pension funds has recently seen a continuous inflow of funds in different nature, for example, private sector firms and university endowments, etc. Another growth driver in the market could be institutional-type retirement pension funds as a relevant bill was recently proposed. However, Korea’s current OCIO model has some distortions that could be a drag on market growth. Compared to overseas cases, the range of delegated tasks and management discretion are excessively limited in Korea’s OCIO market. Potential clients in the OCIO market should be any asset owner who tries to manage large funds with limited expertise and internal resources. What’s necessary for helping that potential demand to enter the market successfully is to build a target-oriented OCIO structure that suits the needs of diverse funds. Korea’s current practice of dedicated management not only dilutes the benefits of the OCIO model, but also hinders the entry of smaller funds such as retirement pension funds. The OCIO model’s unique competitiveness lies in its flexibility that serves both pooled investment for economies of scale and customized investment for individual clients.
Default Options and Target-Date Funds / Jan. 15, 2019
Low investment returns cause retirement plan participants to distrust the retirement pension system itself. That means that conservative investment does not guarantee the stability of the system. To address the structural problem that leads to low investment returns for retirement plans, it is critical to build a well-diversified portfolio aiming for long-term investment. What Korea can learn from experiences of developed countries is that participant education is a limited tool to increase efficiency in pension asset management. Under discussion is the adoption of default options as the most direct and effective tool. However, if a retirement plan offers a default option that includes a certain level of risky assets in the absence of participant investment direction, it is likely to face liability for investment losses. A relief from liability for investment losses should be thus given to a default setter. With such condition, a financial regulator needs to define and manage qualified default investment alternatives (QDIAs) which can be used as a default option. Although various types of investment strategies can be QDIAs, life-cycle funds such as target-date funds are expected to have competitive advantages over other investments considering the features of retirement plans. As steps in preparing for the adoption of default options, it is necessary to develop Korean-style target-date funds which suit local circumstances, especially in terms of sub-funds composition and glide path design, and to accumulate track records of managing such funds.

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