Performance of Active and Passive Management of Korea's NPS Funds

• Published date: 01 August 2017
• Author: Jhinyoung Shin,Jaeuk Khil,Jay M. Chung
• Date: 01 August 2017
• DOI: http://doi.org/10.1111/ajfs.12180

Performance of Active and Passive

Management of Korea’s NPS Funds*

Jay M. Chung

College of Business Administration, Soongsil University, Republic of Korea

Jaeuk Khil**

Department of Business Administration, Hanyang University, Republic of Korea

Jhinyoung Shin

School of Business, Yonsei University, Republic of Korea

Received 29 June 2016; Accepted 27 March 2017

Abstract

We evaluate the performance and the performance persistence of actively and passively man-

aged domestic equity funds of Korea’s National Pension Service (the NPS) during the period

2002 to 2011. The results show that active funds did not statistically outperform passive

funds during the sample period, and the superior performance of some active funds was dri-

ven not by skill but by luck. Our results are consistent with those of earlier research on US

institutional investment products, and provide empirical support for the NPS’s recent shift in

investment policy from active management to passive management.

Keywords Active management; Equity fund; Fund performance; National Pension Service;

Passive management

JEL Classification: G11, G14, G23

1. Introduction

Korea’s National Pension Service (the NPS) is the third-largest pension fund in the

world, with total assets under management of KRW512 trillion (US$434 billion) as

of 2016. The NPS’s domestic equity investment totals KRW96 trillion (US$81

*This work was supported by the National Research Foundation of Korea Grant funded by

the Korean Government NRF-2013S1A2A2035472. The authors are grateful for their financial

support under the Global Research Network Program. An earlier version of the paper was

initiated by Professor Bong-Soo Lee who sadly passed away during the project period. Com-

ments from the referees and the editor are gratefully appreciated.

**Corresponding author: Jaeuk Khil, Department of Business Administration, Hanyang

University, Ansan 15588, South Korea. Tel: +82-31-400-5654, Fax: 82-31-400-5591, email:

jkhil@hanyang. ac.kr.

Asia-Pacific Journal of Financial Studies (2017) 46, 535–557 doi:10.1111/ajfs.12180

©2017 Korean Securities Association 535

billion), of which KRW68 trillion (US$58 billion) is actively managed and KRW28

trillion (US$24 billion) is passively managed.

It is generally believed that the NPS has a strong internal equity management

team and that it has built expertise in selecting external fund managers who can

generate superior performance. In 2016, the NPS overhauled its investment policy,

shifting its domestic equity investments from active management to passive man-

agement. By the time this policy change is completed, the NPS’s balance of actively

managed domestic equity funds will be reduced by KRW4 trillion (US$3 billion),

and will be reinvested in passive funds that earn a stable stream of profit from the

domestic equity market. Other Korean institutional investors, such as the Teachers’

Pension and Government Employees Pension Service, will follow and increase their

shares of exchange-traded funds to 15%. A major reason for the NPS’s decision to

change its domestic equity investment strategy is that the NPS’s share of the Korean

domestic equity market was so high that conducting an active management strategy

heavily affected the market. In order to evaluate the change in the NPS’s domestic

investment policy, the performance of active and passive managers must be com-

pared from both a practical and academic perspective.

One useful comparison is with the largest pension fund in the world, Japan’s

JPY131 trillion (US$1.1 trillion) Government Pension Investment Fund (GPIF). Fol-

lowing the GPIF’s 2014 announcement that it would increase its total risk profile

by reducing fixed-income investments while increasing equity investments, it began

allocating more equity investments to active management. Since 2014, GPIF’s equity

exposure has risen from 24% to 50%, with both domestic and foreign equity invest-

ment growing from 12% to 25%. Until recently, most of the GPIF’s equity invest-

ments were managed by passive funds, with JPY18.3 trillion managed by ten passive

domestic equity funds and JPY2.6 trillion in active funds managed by 14 managers.

For foreign stocks, six managers oversee JPY17.6 trillion in passive strategies, and

15 managers oversee JPY2.1 trillion in active investments.

With its aggressive expansion into equity investments, the GPIF will be more

active in Japanese equity markets, with enthusiastic support from those who favor

Abenomics, economic policy based on fiscal stimulus, monetary easing, and struc-

tural reform. However, recent increased volatility of the returns of the GPIF’s assets

under management has rekindled the debate on the roles of passive and active

equity management. In the first half of 2016, the GPIF expanded its active manage-

ment team in an effort to offset poor performance from passive equity investment

strategies.

For several decades, academics and investment practitioners have debated the

merits of active versus passive investment management in the mutual fund industry.

The recent decisions of the NPS and the GPIF offer another opportunity to investi-

gate this issue for large pension funds’ equity investments. According to Sharpe

(1991, p. 7), if active and passive management styles are defined sensibly, then it

must be the case that “(1) before costs, the returns on the average actively managed

dollar will equal the returns on the average passively managed dollar and (2) after

J. M. Chung et al.

536 ©2017 Korean Securities Association