Controversy surrounds the strategic decision by South Korea’s US$751 National Pension Service (NPS) to rapidly exit domestic public equities in favor of foreign investment - and the impact this is having on retail investors. Yet, the shift is crucial to boosting returns and addressing the long-term prospect of depletion of the world's third biggest pension fund.

This week, the NPS announced an US$887 million tie up with BC Partners for joint investment in assets sourced by the London-based private equity fund. The deal is the latest in a number of tie-ups secured by the Korean pension behemoth. Earlier this month, the fund committed US$500 million to Blackstone's new life science real estate fund, which has a target of over US$12 billion. In December, it set up a US$1.5 billion joint venture with the US-based real estate investment firm Hines for a build-to-core portfolio and a joint venture with Stockbridge for Class A logistics facilities estimated at US$2 billion. In June, it secured a US$2.3 billion property joint venture with Allianz.

The deals are part of the fund’s bid to raise allocations to alternatives from 10.9% at end-2020 to 15% by 2025. In 2020, it added a total of 15 managers for its global alternatives investments with a total of 160 overseas alternative investment managers engaged to manage US$58 billion in assets,

At the same time, retail investors in Korea are increasingly restive over the bear market created by a lengthy selldown of stocks on the KOSPI by Korean public pension funds. The NPS and other domestic PPFs briefly paused their net sales of domestic stocks on March 12 after a 51-day selling binge. PPFs sold a total of KRW14.5 trillion (US$12.8 billion) of KOSPI stocks over the period, dragging down stock values and impacting heavily on enraged retail investors. Korean funds have not ended their selling as they continue to adjust their portfolios to reduce the proportion of domestic stocks.

The NPS reduced the proportion of Korean stocks from 20% in 2016 to 17.3% in 2020 and plans to cut exposure further to 16.8% this year. The money has flowed out of Korea with foreign stocks rising from 13.1% to 25.1% over the same period. Given the fund’s size, a mere 0.5 percentage point reduction in domestic stocks means US$3.76 billion flowing out of Korea into foreign assets.

The strategic shift makes sense for a fund that has a mandate to maximise returns for stakeholders – particularly bearing in mind the likelihood that it will be in deficit in 20 years and risks depletion by 2057, according to government projections.

The NPS remains heavily weighted towards a domestic portfolio that represented 65% of AUM by end-2019 – much higher than GPIF’s 50% weight of Japanese stocks and bonds. The Korean fund aims to raise foreign holdings to 55% of its portfolio by 2025. With overseas investments earning a five year average return of 10.06% to 3.69% for domestic assets, the strategy employed by the NPS makes good financial sense. While a backlash will be loudly heard in a democratic society like South Korea, short-term discontent is a price worth paying to deal with the far greater challenge of the needs of an ageing national demographic.

Related funds GPIF NPS