Pension funds should consider raising their allocation to domestic equities to prevent depletion caused by aging demographics and slow growth, experts said.
Lee Hyo-seob, head of the financial industry division at the Korea Capital Market Institute, said in a keynote presentation at the "Desirable Asset Allocation Strategies for Pension Funds" symposium held in Yeouido, Seoul, on Tuesday that "the KOSPI's price-to-book ratio (PBR) stood at 2.4 times last month, suggesting its chronic undervaluation has been resolved." He added that "it is necessary to review raising the target allocation in consideration of a KOSPI re-rating." He argued that investment strategies must change as Korea's capital market has entered premium territory.
A PBR below 1 indicates that a company's market value is less than its net asset value, serving as a measure of undervaluation. Korea's PBR now exceeds those of Germany (1.92 times), Japan (2.01 times) and China (1.57 times).
According to the institute, domestic stocks accounted for 16% of Korean pension funds' investment portfolios last year, up 6 percentage points from the previous year. The increase reflects a sharp rise in domestic equities driven by improved corporate earnings and policies to invigorate the capital market.
"If the KOSPI's Sharpe ratio, which measures return relative to risk, is expected to rise on the back of ongoing market revitalization policies such as the ban on duplicate listings and the correction of low PBRs, raising the target weight for domestic stocks becomes feasible," Lee stressed. He added that when target allocations are raised, flexible rebalancing strategies should be established through improvements in permissible investment ranges.
Lee also argued that pension funds should adopt a Total Portfolio Approach (TPA) that takes Asset Liability Management (ALM) into account to achieve rational asset allocation. Under this framework, the share of risky assets would be adjusted to 75% during the pension growth phase, 60% during the transition phase and 30% during the decline phase. The National Pension Service currently holds 65% of its portfolio in risky assets, and expanding this to 75% merits review, he said.
"New Investors in U.S. Stocks
May Fall Short of Average Returns"
Meanwhile, John Campbell, a professor of economics at Harvard University and a leading authority on asset allocation, also attended as a keynote speaker and explained strategic asset allocation directions during a period of structural transition. Campbell's book "Strategic Asset Allocation" is considered a textbook for global institutional investors.
While acknowledging that value-based asset allocation has been severely shaken by the recent artificial intelligence (AI)-driven stock market rally, Campbell argued that it is difficult to conclude that this underperformance represents a structural death sentence for value stocks.
"The unusually wide value spread we see today may be because value risk has been rationally repriced, but it may also be due to irrational exuberance pushing up the prices of AI-related stocks," Campbell said. "Historically, wide value spreads have foreshadowed high future returns for value stocks." He added, "Investors should build investment strategies by considering economic theory together with supporting statistical evidence, rather than relying solely on simple statistical figures."
Value analysis is also useful for assessing how expensive the entire U.S. stock market currently is, and the high price level in the U.S. market may largely reflect a decline in discount rates, he said. Citing the current U.S. market's cyclically adjusted price-to-earnings ratio (CAPE)—calculated using the inflation-adjusted S&P 500 index and the 10-year average of earnings per share—of 36 times as very high, Campbell said, "I believe the expected long-term return on U.S. stocks is likely to be below average."
"This does not mean a crash in the U.S. market," he said, but added, "Investors who buy in at current price levels are likely to have to accept returns that fall short of the historical average."
