KIC’s 2014 Report: A Headscratcher for Analysts and Stakeholders Alike

May 20, 2015 by Loch Adamson

#KIC's AuM surges from $72 billion to $84.7 billion in 2014
"Frustrating" lack of clarity in #KIC annual report, says GeoEconomica
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South Korean Ministry of Finance Ministry of Strategy and Finance, Seoul

The Korea Investment Corp. (KIC) published its 2014 annual report last week, which showed a big increase in the fund’s assets under management. But the the fund’s surge in value in some ways remains a mystery.

It’s the start of annual report season for sovereign wealth funds. That means deciphering the often obtuse filings of state-owned investors whose disclosures are, shall we say, unconventional. Case in point: Korea Investment Corp. (KIC), whose financial reporting has in the past prompted head-scratching among market commentators and fund stakeholders.

Last July, for example, the fund published its 2013 annual report on its website before removing it days later. The report finally resurfaced on the site in September — minus some underwhelming performance figures for alternative asset classes.

Fast-forward eight months and KIC’s 2014 Korean language annual report and English language audited statements are generating more bewilderment among those who are sifting through their numbers. Most interesting: The Korean-language document states the fund’s assets under management surged to $84.7 billion over the twelve months to December 31, 2014, up 17.6 percent from the $72 billion figure recorded for end-2013. Impressive figures, to be sure — but the report does little to explain the increase.

In an emailed response to questions KIC spokesperson Nayoung Sung attributed the rise in assets to "both [the] fund’s investment return and capital inflow from KIC sponsors". But according to the data provided in the report, KIC’s investments returned 3.8 percent ($2.7 billion) in dollar terms — decent gains, but not nearly enough to account for the $12 billion rise in the fund’s overall value. Similarly, KIC’s audited accounts reveal that it received a capital injection from the Ministry of Strategy and Finance of KRW 172 billion ($157.6 million) over the period. Again, the numbers don’t add up.

"Lack of Clarity"

Sven Behrendt, founder of Geneva-based consulting firm GeoEconomica, says the report has left him confused. "[The growth in assets] could be from currencies," he speculates. That’s possible — KIC holds its assets in a basket of different currencies, and discloses its percentage returns on individual asset classes in both dollar terms and the currency basket. For instance, the fund’s equity investments returned 4.8 percent in dollars and 10.9 percent in the currency basket.

Muddling the issue, however, is the fact that the overall rise in assets was reported in dollars, which remained extremely strong over the reporting period. Behrendt, for one, has experience with opacity of the KIC’s disclosure. "The lack of clarity is frustrating," he says. Trying to decipher the 2013 report was especially so. "I remember shouting at the computer screen," he says.

Interestingly, the surge in assets has occurred at a time when the fund appears to have been removing risk from its portfolio. After lowering its allocation to fixed income in 2013 as it hunted for higher returns, it reversed itself, moving heavily into bonds last year, increasing its allocation to 39.2 percent as of December 31, 2014 from 34.3 percent a year earlier. 

Equities, meanwhile, were reduced to 43.8 percent from 48.4 percent, while alternative assets were down slightly, from 9.3 percent to 9 percent, despite Chief Investment Officer Heungsik Choo’s stated goal of raising the fund’s alternatives exposure to 40 percent by 2017. This asset allocation suggests the fund is emphasizing liquidity over investment return.

Santiago Principles

KIC’s report raises other questions. For example, the audited financials show that KIC bought a 40 percent stake in an investment vehicle named K-REALTY last year for around KRW 16 billion ($14.6 million). K-REALTY was used by Seoul-based, New York-listed conglomerate KT Corp. to buy HMLC Co., a company that owns an office building in the center of the Korean capital.

That might not seem unusual. Many sovereign funds target commercial real estate in Seoul. Indeed, on Monday this week, Singapore’s GIC announced it had teamed up with the Canada Pension Plan Investment Board (CPPIB) to buy a shopping mall in the city from Daesung Industries for $263 million. But KIC’s founding legislation proscribes it from investing in domestic real estate. 

In the emailed note, Ms. Sung clarifies this point. She says that while the founding legislation does indeed prohibit investment in domestic assets, the rule in practice only applies to KIC’s allocation of the original seed capital it received from the government. The fund is free to reinvest its own profits in whatever assets it sees fit — including South Korean real estate. How the fund distinguishes between seed capital and its profits is not clear. 

And KIC’s overall rise in assets during a period of apparent retrenchment remains mysterious. Behrendt says some confusion may derive from the fact that KIC’s audited reports pertain to the fund as an investment management entity, not the performance of the underlying portfolio that it oversees. The Santiago Principles on corporate governance oblige a fund to prepare its annual report and other financial statements in accordance with recognized international or national accounting standards. KIC used accounting standards for non-public entities in the Republic of Korea.

Minimal Disclosure

All things considered, KIC’s public notices habitually raise questions for stakeholders seeking to fathom the sovereign wealth fund’s status and performance. This may have something to do with the fund’s preoccupation with its reputation.

Last summer, for example, Choo spoke at a regional investment conference and took the opportunity to lament the fact that KIC’s standing on the international markets remains "not all that favorable", despite strong performance in recent years. The fund’s five year return on assets under management through 2013 was 8.3 percent annualized. 

In his speech, Choo said that critics tend to fixate on KIC's investment in Merrill Lynch & Co. The fund invested $2 billion in the troubled U.S. brokerage firm in January 2008 alongside the $548 billion Kuwait Investment Authority, sustaining substantial losses. Choo urged critics to look instead at the fund’s robust overall returns since the 2008-’09 financial crisis. 

Aware that its missteps are scrutinized, KIC seems to have taken to holding its cards close to its chest. It provides only the minimum of information in its public disclosures.

"Broadly Compliant"

When the 2013 annual report re-emerged last September, for example, it lacked some key performance metrics. The revised report no longer included the three-year annualized return figures for hedge funds, private equity and real estate. These had shown that while KIC’s overall alternative investment portfolio grew strongly over 2013, its three-year returns of 4.7 percent lagged its benchmark of 4 percent over G7 inflation. 

The original report also revealed that direct investments generated only 1.4 percent on an annualized basis as of the end of 2013, compared with 10.2 percent for its private equity fund holdings. In October 2014 KIC’s CEO Hongchul Ahn wrote in an emailed note to journalists that direct investment returns had been disappointing and that the fund would be more circumspect in selecting deals in the future.

KIC is certainly not the least transparent of funds. GeoEconomica, for example, last year gave the fund a B on its A to F grade scale for compliance with the Santiago Principles — or "broadly compliant". 

KIC's reticence may well suit its needs, at least from a political standpoint. But it’s leaving financial analysts with plenty to ponder.

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