South Korea’s National Pension Service (NPS) is showing signs of change in the way it selects which private equity funds (PEFs) it will award mandates. 

The world’s third-largest pension fund usually picks up PEFs in two ways. One is the so-called “beauty contest”, where bidders for the mandates compete against each other by making a presentation to the NPS. This system, which was introduced to guarantee better transparency and fairness in the selection process, applies only to the selection process of domestic PEFs. Most of South Korea’s pension funds and mutual aid associations are following this process. 

The other is the screening system where NPS receives proposals from individual PEFs which are in the process of fundraising, reviews them and makes an investment decision. PEFs which have been delivering an internal rate of return (IRR) of 12% while managing NPS investments are qualified to put their names on the “excellent managers” list and receive further mandates without needing to participate in the “beauty contest.” 

This year, however, NPS has made some changes in the latter selection process with the creation of a “preliminary excellent managers system”. It is a system that grants mandate opportunities to PEFs which are qualified to become excellent managers. These include PEFs that have logged more than 12% of IRR but have not yet been included in the “excellent managers” list as their existing funds have not been liquidated. In this case, NPS conducts stricter due diligence on the funds to prevent possible risks such as falling asset values before their liquidation.

If NPS awards new mandates only to PEFs which have liquidated existing funds, there may be some time gap between the mandate time and the funding schedule of PEFs, as PEFs usually start fundraising before the liquidation of existing funds. 

NPS is maintaining its stance on expanding alternative investments to boost long-term returns. To this end, it is important for NPS to invest in PEFs that show excellent track records. The goal of introducing both an “excellent managers system” and “preliminary excellent manager system” is the same – to increase its return. 

Fund industry watchers long called for a broad-based overhaul of the “beauty contest” to better reflect the asset growth and improved expertise of domestic PEFs. The contest was introduced about 10 years ago when South Korea approved of the establishment of home-grown PEFs. Some have pointed out that NPS may not be able to choose qualified PEFs if it focuses too much on fairness and transparency in the evaluation process. 

While many think the “beauty contest” may not be abolished completely, some expect that NPS will expand commitments on a regular basis at a time when talented PEFs raise funds. (Reporting by Heeyeon Han)