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ANALYSIS

Conservative Korea

Korean corporate pension funds have grown more conservative in their investments, increasing already high allocations to guaranteed-insurance contracts (GICs) and term savings, the Towers Watson Korea Pension Report shows.

The annual snapshot of the Korean pension market found that 93 per cent of corporate pension-plan assets are allocated to principal-guaranteed products, of which nearly 58 per cent is invested in cash instruments.

Guaranteed-insurance contracts are insurance policies that promise a fixed or floating interest rate during the policy period.

Jayne Bok, Towers Watson Korea’s director of investment services, says the research indicates a 5-per-cent increase in allocations to principal-guaranteed products last year, indicating the high risk-aversion among both Korean pension-fund sponsors and members.

Much of this increase was caused by significant mandates, mostly invested in GICs, being awarded to two service providers from defined-benefit plans affiliated to them.

“Last year was a bit of a risk-off environment so the service providers who were doing the asset allocation were more conservative, and putting more into cash and bonds than they were into equities,” Bok says.

“There are restrictions that don’t allow you to invest that much in equities to begin with… But the problem is more the starting point, rather than anything that has happened in any particular year. Any kind of risky environment you could see will trigger the same response. The baseline level of risk tolerance in Korea is basically too low.”

Bok believes this conservative allocation is largely influenced by corporate sponsors’ “cash-reserving mentality”, which finds its roots in legacy severance schemes and recent fierce competition among service providers offering attractive or inflated interest rates to attract new clients.

“As a result, there is also an inappropriate focus on capital preservation rather than on income or return generation, which would be more suitable given allocations should be focused on the ability to pay pensions in the longer term,” she says.

 

Regulation and return-seeking assets
Further encouraging conservative investment approaches are government restrictions on defined contribution and individual retirement account (IRA) schemes limiting investments to return seeking assets such as equities.

This conservative approach is at odds with larger public pension funds, such as the National Pension Scheme of Korea, which is in the midst of a four-year program to double its holdings of international equities.

The country’s sovereign wealth fund, the Korean Investment Corporation, under former chief investment officer Scott Kalb, started a five-year plan to double its allocations to private markets, in particular looking at distressed-debt opportunities and real estate.

Corporate pension funds have, however, taken a safety-first approach, preferring principal-guaranteed products.

These GIC providers in the last year have offered interest rates on principal guaranteed products in a range of between 4.21 and 5.1 per cent, Bok says.

Bok points to wage inflation in 2011 as being around 5.5 per cent, based on Towers Watson’s annual compensation surveys, re-enforcing the need to seek better performance than the cash rate.

She expects a rationalisation in fixed-rate products and a gradual lowering of interest rates offered to drive a gradual push to more return-seeking assets.

The pool of $45 billion in Korean corporate pension plans includes both defined-benefit and defined-contribution plans.

 

Guarantees over growth
With funding levels for corporate defined-benefit plans typically around 70 to 80 per cent, funds adopting conservative investment approaches are unlikely to improve these, Bok notes.

Korea adopted a funded pension-plan system similar to those of developing countries in 2005. Bok says the relative infancy of the system also contributes to conservative investment approaches.

“Sponsors and members need time to increase their investment literacy before we can expect to see fundamental changes in their investment behaviour,” according to the report.

Plan sponsors have been focused on whether to adopt a plan and choosing a service provider, with little thought going into the ongoing investment strategy.

“From a chief financial officer’s perspective, if the pension plan costs are less than 1 per cent of your book, you don’t worry too much about how you are going to invest the assets. It is simple to write an insurance contract for a GIC because you then have no worries because someone else is guaranteeing your return,” Bok says.

“So, I can understand why at this early stage of the market we have this kind of behaviour, it is always easier to stick to the current practice than do something different.”

The report reveals that total pension assets grew by 71 per cent in 2011.

Bok says that as this recent exponential growth continues and pension plans loom larger on the balance sheets of companies, it could trigger changes in investment approaches as plan sponsors pay more attention to fees and performance.

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