How to grow public assets – from tourism promotion to disease eradication.

There are 67 public funds in South Korea sustained by charges on public services, insurances and mandatory contributions. These vast amounts of assets direct money to topics as diverse as pension security, tourism promotion and disease eradication. While these funds are growing, not all resources can be spent at the same time. The assets in-waiting, need to be managed just like any other saving. However, what are structures to ensure adequate investment management?

Does a government need asset managers? The answer hardly is “no” for anyone who cares about the efficient investment of public money. In South Korea, with a total of 67 public funds, including one of the world’s most sizeable pension funds, the question instead becomes, how many asset managers are needed? Under efficient direction, the resources can grow to the benefit of the general populous. However, finding an educated workforce of investment professionals in an industry competing with a well-paying private sector is costly. The number of government employees in South Korea already approaches one million. To build out investment management expertise with individuals demanding substantial wages is strenuous to the national budget.

The public funds in South Korea

South Korea created 67 public funds to meet an increasing public service demand that is difficult to achieve using traditional budgeting mechanisms alone. The funds support a diverse set of activities from tourism promotion, trade security, inter-Korean economic cooperation, as well as disease prevention in developing nations. The sources of the funds range from charges on public services, mandatory insurance contributions, and innovative levies on air-tickets. Usually, the income is closely related to the purported project of the fund. The money in-waiting, from inflows being greater than outflows, accumulates over time and requires professional asset management. If administered well, the generated surpluses can be maintained and grown to increase the impact of the funds. The National Finance Act mandates publics fund to manage their assets efficiently, considering stability, profitability and public benefits of its investment

The Investment Pool, a solution for a collective problem

Due to these challenges, the Ministry of Economy and Finance created an investment pool for public funds in 2001. Currently, 63 individual funds consign most of their assets to this pool and essentially outsource a large part of their investment management processes to third parties. The set-up primarily functions as a fund of funds. The merging of different assets in a single structure has a clear goal – to increase the efficiency of asset allocation. It aims to achieve this by entrusting the management to investment professionals, rather than instituting capacities under the government directly. The administrative power over the allotment follows a bidding process, held every four years. Two private firms – Samsung Asset Management and Korea Investment Management Co. – have been repetitively selected as the lead managers running the combined funds.

Better than before, and yet

The private market is expected to have the necessary skills and knowhow to generate a higher return and offer less risk on the investment. Subsequently, the government is under less pressure to expand staff and organisations. Economies of scale are another anticipated benefit as well, allowing small-sized public funds to invest in large-scale projects not accessible before. Furthermore, public funds can lessen worries over market neutrality. However, the structure has been exposed to growing criticism. The idea of entrusting the management process to professionals seems reasonable. Nevertheless, a collective investment pool might not be the best answer.

More upside is needed

The propensity towards too conservative and risk aversive management and the subsequent loss of potential for higher returns is one area of explicit criticism. Additionally, the fund-of-funds (-of funds) allocation of assets involves a significantly higher number of intermediaries. The link between the investment’s origin and the final allocation can be surprisingly long. Subsequent management fees on each step increase the costs and crowds out the possible impact of the individual funds. Furthermore, the market power of the two leading companies is a reason for concern. The two entities are facing nothing near to perfect market competition in the bidding process that follows a conservative status-quo approach. Time has sufficiently proven that such a structure can lead to the abuse of market power and imperfect outcomes.

Technology as a way forward

An increasing number of public funds are now considering alternative set-ups, which include the “Outsourced Chief Investment Officer”. This service is gaining popularity globally and benefits from the increased use of technology in the investment process. Companies in South Korea offering this service include Shinhan-BNP Paris Bas Asset Management and NH Investment & Securities. It has been 18 years since the creation of the pool of national funds. With technological advancements in the asset management value-chain, the original concept could inevitably become subject to criticism. Maybe, it is time to revamp the structure of the shared pool and the approach to the asset allocation.


 

Written by:

Author – Keunwang Nah, born in South-Korea, is currently pursuing a master’s degree at Stanford, specializing in Cyber Policy. He served as an Intelligence Officer in the Republic of Korea Air Force and for the Ministry of Foreign Affairs. Among his experiences, Keunwang was responsible for an 800-million-dollar Global Disease Eradication Fund as part of the Korean Official Development Assistance (ODA) focused on the prevention and eradication of infectious diseases in developing nations. (Follow on LinkedIn)

Co-Author – Julian Osborne, born in Germany, has a master’s degree from the University of Zurich in “Democracy, Development and International Relations”. He has worked for several years in various Financial Services roles related to FinTech and digital innovation. Since 2018, he has been a Representative Director of AAAccell, a Fintech in wealth and asset management and spin-off from the University of Zurich. (Follow on LinkedIn)

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