Sovereign investment fund plans diversification

Korea Investment Corporation, the nation’s sovereign wealth fund, plans to spend as much as $10 billion to triple its allocation to alternative assets, diversifying its portfolio to smooth the fund’s returns.

The sovereign wealth fund, known as KIC, wants to increase holdings of private equity, real estate and hedge funds to as much as 20 percent of its portfolio by 2016 from 6.1 percent at the end of 2012, its chief investment officer said.

“We are going to spend between $5 billion and $10 billion on alternative assets over the next three years,” CIO Lee Dong-ik said. “We like to have a balanced portfolio in terms of strategies and regions.”

KIC is following other state funds or investment companies that are diversifying their assets to achieve more stable returns. Singapore’s Temasek Holdings almost doubled its holdings of unlisted assets to 27 percent of its portfolio in the past eight years, while Australia’s Future Fund increased the proportion of private equity and real estate to 13 percent from 6.3 percent in the three years through March.

Founded in 2005 to invest some of the nation’s foreign-exchange reserves offshore, KIC initially bought bonds before adding equities in 2007. Two years later, it expanded to distressed debt, real estate and private equity for “stable long-term returns,” it said in its annual report for 2009.

Compared with traditional equities and bond holdings, alternative assets have a different risk-return profile and low liquidity or are based on private contracts, KIC said.

“Alternative assets like private equity, real estate and infrastructure are becoming more relevant for sovereign wealth funds,” said Michael Maduell, president of the Las Vegas, Nevada-based Sovereign Wealth Institute. “Investing in those assets reduces return volatility.”

KIC’s investments in hedge funds and real estate have yielded an average 7 percent annually since inception, according to the 2012 annual report published in May. Private equity investments returned 11 percent and special investments, which is KIC’s stake in Bank of America lost 16 percent.

At the end of 2012, KIC managed $57 billion and its asset allocation was almost unchanged from the previous year, with 45 percent equities, 39 percent bonds and about 10 percent mainly in cash, inflation-linked bonds and the stake in Bank of America, according to the report.

The chief investment officer said alternative investments would be evenly spread. “It may be 40 percent private equity, 30 percent real estate and 30 percent hedge funds,” he said.

While Lee, 55, wouldn’t nominate specific property investments that he views as attractive, he said “real estate is a bit overpriced in the big cities like London and New York.”

Real estate topped the list of state funds’ investments last year, overtaking commodities and financial services, the London-based Institutional Investor’s Sovereign Wealth Center said in May. Properties made up 26 percent of investments, up from 14 percent in 2011, the center said.

On its equity investments, KIC reported a 16.2 percent return for 2012, according to its report. The MSCI World Index yielded a total return of 16.7 percent during the same period, according to data. KIC’s bond holdings returned 7.8 percent last year, according to its report. The fund doesn’t publish a return on its total portfolio.

Within the limits of its investment mandate, KIC has “more appetite” for U.S. and European equities as the U.S. economy shows a “fundamental recovery,” Lee said.

Even with the Federal Reserve’s quantitative easing tapering, which Lee thinks will start in the third quarter, “investors will put more money into the developed markets, which means you have to take the money out of the emerging markets,” the CIO said.

The Standard & Poor’s 500 Index has gained 19 percent this year and trades at 16 times its earnings, according to data compiled by Bloomberg. That compares with an 11 percent loss for the MSCI Emerging Markets Index which trades at a price-earnings ratio of 11.

“The Standard & Poor’s index looks a bit overvalued, but you still have to think about where the money is going to go,” the chief investment officer said. “A lot of money is ready to be put into U.S. equities.”

The index could add as much as 10 percent by the end of the year, he said. “And as money flows into the U.S. market, it will definitely strengthen the dollar.”

With the U.S. economy improving, interest rates will rise, making fixed income “less attractive,” he said.

KIC also plans to expand its investment in China, Lee said. In 2011, the fund was granted a license from Chinese authorities to invest in the country’s stock market under the Qualified Foreign Institutional Investor, or QFII, status.

KIC’s quota is capped at $400 million, Lee said, adding that 80 percent of that amount is going into equities and 20 percent in bonds. The quota is less than 1 percent of KIC’s assets, which “doesn’t make sense” given the size of China’s economy, he said.

“As we grow, we plan to expand this quota and we’ll keep applying to the government,” Lee said. “We have to follow the government’s speed of market liberalization.”

The chief investment officer also said the state fund will maintain its stake in Bank of America.

KIC initially bought the $2 billion stake in Merrill Lynch & Co. in February 2008, months before the firm was forced to sell itself to Bank of America. The sovereign wealth fund held a 0.68 percent stake as of March 31, according to data compiled by Bloomberg.

“For us, the bank is a proxy of the U.S. economy,” Lee said. “There is no reason to sell.”

Bloomberg