Alternative investments by the National Pension Service (NPS) stood at 84.3 trillion won ($71.1 billion) as of December 31, 2019, comprising 11.4% of the total assets and up 7.7 trillion won from a year ago, according to the NPS 2019 Annual Reportreleased on August 11.

NPS has been expanding its investments in alternative assets such as real estate, infrastructure, private equities and overseas hedge funds since 2002, not only to increase its returns but also to diversify its risks. It strongly believes that alternative investments contribute to generating sustainable returns for the total portfolio with their distinct risk-return profile from traditional asset classes like stocks and bonds.

With an emphasis on investment diversification, allocations to foreign alternative assets expanded to 59.6 trillion won, or 70.6% of the total alternative investment portfolio as of the end of last year, up 7.3 trillion won year-on-year. Meanwhile, domestic alternative investments have also risen by 400 billion won to 24.8 trillion won, comprising 29.4% of the total alternative investment portfolio.

By asset classes, real estate investment registered 37.1% of the total alternative investment portfolio, followed by private equities (34.9%) and infrastructure (28.1%). Allocation to private equities rose by 3.9 trillion won from a year earlier, the largest increase among the alternative investment assets. And allocation to real estate and infrastructure increased by 2.9 trillion won and 900 billion won respectively.

By region, the domestic alternative investment reported an annual return of 7.08% (+0.46% points relative to the benchmark), while the global alternative investment posted an annual return of 11.09% (-0.01% points relative to the benchmark). Currency exchange gains from the strong US dollar contributed to delivering double-digit returns in the global portfolio over the last year.

Experts’ Comments

“Let’s tackle what it means that NPS global alternative investment portfolio has returned 11.09% last year. We know from NPS historical performance that, in general, three components contribute to the reported annual return — 1, realized earnings, i.e interest, dividends, capital gains etc; 2, fair market value of capital appreciation and 3,  FX adjustment. A few years ago the reported return was around 15 to 16%, each of the three components represented approximately one-third of the total return.

The tricky part is the second component, capital appreciation. When it comes to the real estate and infrastructure sector, the equity value gets inflated as the interest rate drops. Particularly the scope of capital appreciation widens as the underlying assets have a longer investment horizon. Real estate and infrastructure sector portfolio roughly cover at least two thirds of NPS global alternative asset classes.

One of the key differences to note is that for domestic alternative assets NPS takes a third-party asset/fund appraiser’s price as the fair market value while NPS takes GP’s reported fair market value as its reference price.” (by an industry source)

NPS’s future overseas investment plans 

The world’s third largest investor, with assets under its management reaching about 750 trillion won ($632 billion) as of the end of May, plans to sharply increase its overseas investment to maximize its returns and diversify risks amid the new coronavirus pandemic.

“It is inevitable for the NPS to expand its overseas investment to disperse risks and overcome limits of the domestic market,” said Park Neung-hoo, minister of NPS’s overseer Ministry of Health and Welfare late last month. 

NPS is in the process of shifting its allocations from domestic fixed income toward foreign assets and alternative assets. In particular, global alternative investments first outweighed domestic alternative investments in 2014 and have since grown gradually to 70.6% of the total alternative investment portfolio as of the end of 2019. 

NPS plans to expand its staff who specialize in overseas investment from the current 150 to 350 by the end of 2024 to find profitable overseas alternative investments. It will also invest in the stakes of global management companies and seek to establish strategic partnerships with other leading pension funds.

Meanwhile, NPS has undertaken a wide range of activities to expand overseas alternative assets over the past years, including: 1, reforming organization structure to enable a seamless investment process, removing obstacles in investment execution and thereby remaining competitive in the market; 2, studying means to introduce a fast track decision-making process; 3, bringing investment into foreign single hedge funds and 4, building a new strategy building platform. (by Capital Connect)