Korea LPs: Credit junkies

The Public Officials Benefit Association (POBA), which manages KRW10.5 trillion ($9.3 billion) of retirement savings for South Korea’s public officials, has little option but to increase its allocations to offshore investments and alternatives. The policy interest rate is at a record low of 1.25% and POBA must meet a return target of at least 5%. It is trying to make up by channeling capital out of fixed income and into asset classes that deliver more alpha.

Overseas investments have increased significantly over the last two years and now account for about 35% of total assets. The pension fund wants to its allocation to alternatives to reach 50% across private equity, real estate, to infrastructure and hedge funds.

“Our ultimate aim is not to go for a double-digit return, but to invest in assets that can generate stable cash flow with minimal investment risk,” Dong Hun Jang, CIO at POBA, told the AVCJ Korea Forum. “While we’re diversifying our allocation to include buyouts and secondaries on the PE side, there is another area that particularly interests us and where we want to build our exposure: private debt.” 

POBA isn’t the only Korean LP with this mindset. Having started with investments in secured loans in developed markets, pension funds and insurance companies are looking at a wider range of credit strategies, including mezzanine financing products and funds dedicated to real estate and infrastructure-related debt. Once stoically low risk, they are now considering medium risk-return options.

“Korean LPs have been allocating capital to offshore private credit funds for quite some time, but I do see there is still a demand for credit. First, it’s because of the size of those organizations and the amount of capital they need to deploy. Second, they want to diversify their allocations in terms of credit strategy and geography,” says Jackson Chan, a managing director at placement agent Eaton Partners.

Finding niches

In the wake of the global financial crisis, Asian institutional investors increasingly put risk-mitigated credit investments into their portfolios for downside protection. They wanted a stable, long-term annual return, even if it was only 6-8%, and this attitude hasn’t changed.

Korea Post Insurance makes for an interesting example. The government-backed institution manages KRW50 trillion, of which only 6% is deployed in alternatives and the bulk of that is in real estate. More money will be put into alternatives, but it will go to private credit, including mezzanine funds. “Our institution is risk-averse, so we prefer private debt like senior secured loans. It gives us regular income and helps mitigate the j-curve effect,” said Hyun-Woo Jin, a deputy director in Korea Post’s alternative investment division. “When there are unexpected credit defaults, there is still preserved capital.”  

Most Korean LPs invest in developed market credit funds because the volatility is lower. However, Jin raised concerns about capital oversupply pushing up valuations given the sheer volume of credit funds raised in the US in recent years. As such, Korea Post participates in private equity fund-of-funds as well, and Jin would like to start making direct commitments to certain buyout funds over the next 1-3 years.

Meanwhile, large institutions that already have credit exposure are pursuing diversification within the credit space itself, looking at infrastructure debt and real estate project financing. Insurance companies are expected to become particularly active in this area as a result of regulatory change.

The Financial Supervisory Service (FSS) is currently considering measures that would relax the risk-based capital (RBC) ratio – the proportion of assets that must be held in cash – as it applies to domestic insurers investing in offshore real assets, enabling them to put more money to work. The ratio for infrastructure projects and real estate is expected to be reduced to 6% and 4.5%, respectively, from the current 12% and 9%.

Hyundai Marine & Fire Insurance launched its overseas investment program three years ago – it has KRW32 trillion under management, with 4% deployed offshore – covering real estate, infrastructure, private debt, and secondaries. The insurer is expanding its exposure to overseas infrastructure, with buyouts and co-investment to follow. It also wants to provide direct financing on sponsor-backed corporate M&A deals.

“We prefer sponsor deals because the transaction process is more transparent. If there are several institutions participating in the same deal, the valuation and the quality of the assets have been carefully evaluated,” said Kyung-Cheol Jeon, a general manager in Hyundai’s alternative investment department. “For us, non-sponsor deals require more experienced managers to look after them.”

Concentrated portfolios

The US and Europe account for 90% of Hyundai’s total overseas investments, with the rest deployed in Asia. Much like other Korean LPs, Hyundai has little interest in expanding the Asia share because private debt markets the region are relatively small.

“In Asia, it’s all about volume and whether or not the market has the volume to justify large credit funds, because quite often private debt funds charge fees based on invested capital. Indeed [Korean] LPs in this room insist on that because of the returns. So you need a fund of size and you need to be able to deploy it. And the issue in Asia is the market [isn’t big enough],” Chris Heine, senior managing director and head of Asia in ICG, told a separate panel at the forum.

While Korean LPs want to diversify their credit investment spectrum, this is unlikely to involve building relationships with a wider network of GPs. The rationale is that they have limited resources. LPs therefore go for larger funds operated by managers with strong reputations and use separately-managed accounts to increase exposure to certain asset classes.

“Although there are a lot of new funds coming up in the US, it’s very hard for them to attract Korean investors’ attention until they have established longer track records and achieved a certain fund size,” Eaton’s Chan adds. 

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