Strategic partners in fashion with Korean plans

Follow U.S. model to diversify from domestic securities

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Learning: Terence Lim said strategic partnerships let plans gain expertise along with investment diversification.

(updated with correction)

Korean institutional investors are following the lead of several U.S. pension funds in hiring money managers as strategic partners, creating supersized mandates that include investment training and insights as well as managing assets.

The move by the Korean funds parallels a separate trend toward diversifying away from domestic stocks and bonds.

“As a way to diversify their asset base, Korean pension funds are considering strategic partnerships with global asset managers,” said Terence Lim, Seoul-based co-CEO of Goldman Sachs Asset Management in Korea. “Pension funds are looking for ways to gain expertise as they diversify, so training, education and knowledge transfer seem to be all part of these global mandates.”

The 17 trillion won ($14.4 billion) Korea Teachers' Credit Union pension fund, Seoul, recently chose GSAM, Fidelity International and three other managers as strategic partners on a trial basis. Within about six months, the pension fund is expected to hand out substantial mandates to firms chosen for more formal partnerships. The names of the other managers could not be learned; attempts to reach KTCU officials for comment were unsuccessful.

The 295 trillion won National Pension Service, Seoul, which began its strategic partnership program in 2008 with two multiasset managers, now is requiring all new single-asset class managers to share market and trading insights, experts said.

In fact, it's becoming increasingly common for investors throughout Asia to hire managers with some expectation of training or sharing insights.

“We're seeing this popping up more and more” among Korean public plans, Joseph Kim, Seoul-based head of investment consulting in Korea for Mercer LLC, said in an interview. Corporate plans are less established and generally aren't venturing away from domestic investments yet, he said.

“As investors are getting more sophisticated, they're looking (to use strategic relationships in) more asset classes,” Mr. Lim said.

Korea Investment Corp., the country's $29.6 billion sovereign wealth fund, might look to hire strategic partners in the near future, although the structure of such a partnership has not been decided, Scott Kalb, chief investment officer, said in an e-mail response to questions. “We are interested in the concept and (are) working on putting together a program that meets the requirements and objectives of the KIC and that can help us to perform at a higher level,” Mr. Kalb said. Mr. Kim said public megafunds such as National Pension Service have substantial internal resources, but use strategic partnerships to buttress their understanding of global investments and to take advantage of managers' global research and experience. Meanwhile, second-tier funds, such as KTCU and the 11 trillion won Korea Teachers Pension Fund, also of Seoul, rely more heavily on strategic partners to increase their knowledge and understanding of investing outside of Korea.

While pension funds use the partnerships to boost their internal capabilities, “that doesn't mean they want to be independent in the future and manage all assets internally,” said Austin Kweon, head of retirement and benefits consulting in Korea for Hewitt Associates in Seoul. “That's not the plan.”

Advice given in these partnerships isn't always about investments. Carlo Venes, Hong Kong-based managing director and head of institutional business in Asia for Fidelity International, said fund executives often want insight on running a money management business, and risk management has been a topic since the onset of the financial crisis.

“People now take a lot less-quantifiable areas of risk into account,” Mr. Venes said. “They really want to understand how we, as an organization, handle risk for our clients.”

Texas plan as guide

Mr. Kweon said Korean pension fund officials look to the $4 billion strategic partnership program at the Teacher Retirement System of Texas, Austin, as somewhat of a benchmark for their own efforts.

Texas Teachers seems an apt model: Chief Investment Officer T. Britton Harris IV brought the idea to the $96.7 billion fund in 2008 after setting up the first strategic partnership program in 1995 at GTE Corp.'s defined benefit plan (Pensions & Investments, May 12, 2008).

The program is working well at the Texas fund, having topped its custom benchmark by 2.42 percentage points since inception through March 31. BlackRock (BLK) Inc. (BLK), J.P. Morgan Asset Management (JPM), Morgan Stanley (MS) Investment Management and Neuberger Berman LLC each run about $1 billion for TRS, provide proprietary research and meet regularly with pension staff. “It's a very high-touch relationship, unlike other programs,” said Mohan Balachandran,senior investment manager in TRS' asset allocation group.

Insights from strategic partners paid big dividends for TRS in 2009. Information gained from the program led the fund to invest $4 billion in dislocated credit that returned 34% for the year. The program also has helped the fund navigate regulatory changes, better estimate transaction costs, and better understand new asset classes.

Michael Burns, chief investment officer of the $34.5 billion Alaska Permanent Fund, Juneau, said it's too early to use returns to evaluate his fund's version of strategic partnerships called the “external CIO” program, but it's “been a nice resource for us.” AQR Capital Management LLC; Bridgewater Associates LP; GSAM; Grantham, Mayo, Van Otterloo & Co. LLC; and Pacific Investment Management Co. LLC each runs about $500 million in the program.

Fund staff has “spent quite a bit of time” in those managers' offices as well as inviting executives at those firms to Juneau. “It's been a very healthy interchange,” he said.

Not all strategic partnerships programs in the U.S. have been so successful, however. For example, a proposal in April 2008 at the $5.9 billion Arizona Public Safety Personnel Retirement System, Phoenix, to hand over 90% of assets to four index-plus “master managers” fell through. The proposal drew contention from the fund's consultant at the time, Ennis Knupp, which resigned. Rob Brown, the fund's former CIO and architect of the proposal, also resigned later that year.

Consultants in Korea don't necessarily recommend strategic partnerships to clients. For starters, costs can be higher because of the additional services.

“Nothing's ever given up for free,” Mercer's Mr. Kim said. “There's an implied cost embedded in it.”

Fidelity's Mr. Venes disagreed, saying, “compensation in the institutional space is not something that's necessarily reflected in fees.” In addition to typically large mandates, managers view the relationships with funds and the insight into new markets, such as Korea, as benefits of strategic partnerships.

Still, Mr. Kim said partnerships “need to be reviewed very carefully ... you need to consider the firm's philosophy overall.”

Plus, there is the potential for conflicts of interest. “When you're giving advice and managing assets, there could be the potential that you're advising into your own products,” he said.

Jayne Bok, Seoul-based director of investment services, Korea, for Towers Watson & Co., said most strategic partnerships are born out of necessity, rather than being the ideal solution. “We don't have a very deep talent pool for overseas investing in general,” she said.

But Ms. Bok is skeptical that the training or knowledge-transfer element typically found in these partnerships will truly benefit investors. “I'm personally yet to be convinced that the training actually sticks,” she said, because the pension fund staff member being trained needs to return to — and stay with — the fund and be able to apply the training for it to be effective. Applying training can be difficult because of corporate cultural differences between managers and funds. Also, it's usually junior staff members being trained, whereas “where you need to drive change is at the top” of an organization, she said.