NPS in dilemma as overseas stocks deliver higher returns than local stocks

[Photo by Lee Seung-hwan]

South Korea’s National Pension Service (NPS), the country’s largest institutional investor, is faced with a dilemma as the returns from overseas stock investments are higher than those of domestic stocks.

To prevent fund depletion and boost returns, the NPS should raise investments in foreign stocks but concerns are that the move could dampen investor sentiment given its key position in the Korean stock market.

According to the NPS Investment Management on Wednesday, the size of domestic stock assets invested by the NPS stood at 141 trillion won ($105.6 billion) as of the end of November 2023. The asset size of foreign stocks was more than double at 303 trillion won.

Currently, the total assets of the pension fund are about 1,000 trillion won, with 30 percent invested in foreign stocks and 14 percent in domestic stocks.

Of the foreign stock investments, 64 percent are invested in the U.S. stock market.

The NPS’s holdings in domestic and foreign stocks were similar in size in 2018, with 109 trillion won in domestic stocks and 113 trillion won in foreign stocks.

In just five years, however, the size of foreign stock assets rose by 168 percent, while domestic stocks grew by only 29 percent, leading to a doubling of the asset value gap.

Overseas stocks also deliver higher returns.

In 2023, the NPS’s preliminary annualized return on foreign stocks was 17.8 percent, higher than the 16.5 percent for domestic stocks.

Domestic stocks have not outperformed foreign stocks since 2018. The long-term return on domestic stocks from 1988 to November 2023 was 5.2 percent, compared to 8.5 percent for foreign stocks.

In 2022, a year of weak performance in major stock markets, the return on domestic stock investments was minus 22.8 percent.

In contrast, the return on foreign stocks was minus 12.3 percent, about 10 percentage points higher than domestic stocks.

This was due to the strong performance of foreign stock assets, which largely mirrors the performance of the U.S. market in both bull and bear markets.

The NPS, which is engaged in efforts to prevent fund depletion, is likely to increase overseas investment, including foreign stocks, according to sources.

The pension fund plans to raise its overseas investment ratio to 60 percent by 2028.

The NPS’s move to strengthen overseas investment is also evident in changes to its decision-making structure.

The NPS is preparing to revise regulations to include the heads of overseas offices among the members of its investment and alternative investment committees.

It also raised the rank of overseas office heads to the level of director, enhancing their role and status.

“The intention is to strengthen overseas communication and functions in line with the expansion of overseas investments,” the NPS Investment Management said.

However, there are concerns about the impact on the domestic market.

As a major shareholder of many Korean stocks, the NPS’s move could have a significant impact on the capital market.

Increasing the proportion of overseas investments with limited resources could lead to a decrease in the proportion of domestic stock investments, potentially negatively impacting the domestic stock market supply.

Pension funds including the NPS have been net sellers of about 710 billion won in the main Kospi market this year to date, which has fallen by 5.96 percent since January.

For the NPS to balance its portfolio, experts advise that it should not differentiate between domestic and foreign markets but rather improve long-term returns through diversified investments across various asset classes.

They suggest that NPS should emulate the integrated portfolio management system of the Canada Pension Plan Investment Board (CPPIB).

“The NPS’s proportion of risky assets, including stocks and alternative investments, stands at 55 percent, which is lower than CPPIB’s 85 percent, resulting in lower returns in 2022,” said Nam Jae-woo, a research fellow at the Korea Capital Market Institute. “The NPS should properly allocate various asset classes to boost returns.”