[Viewpoint] National Pension Fund Division and Strategies for Improving Fund Management

The National Assembly Legislative Research Office recently argued in its report "2020 National Audit Issue Analysis" that it is necessary to consider dividing the National Pension Fund, which is expected to grow in size in the future, to operate it more efficiently. As of the end of May, the National Pension Fund, which amounts to 750 trillion won, is projected to surpass 1,000 trillion won in four years. As the scale grows, operational difficulties are increasing. In particular, the asset allocation with a high proportion of domestic assets holds significant dominance and influence over the domestic financial market, which indeed acts as a serious constraint on improving operational returns and risk management.

The proposal to divide the National Pension Fund for operation has been raised for several years. The biggest advantage presented by proponents of divided operation is that competition among funds is induced, and each fund can invest by reflecting various perspectives related to management, thereby increasing the overall operational returns of the National Pension Fund while dispersing operational risks. They argue that this can control excessive influence on the domestic financial market and prevent risks of bias toward specific asset classes or investment strategies.

Opponents of division counter that divided operation increases management costs and weakens the bargaining power that a large single fund can have, potentially worsening performance. In fact, Sweden's public pension (AP), which first divided its fund in 1960 and has been operating six divided funds since 2001, has seen increased management costs but no significant difference in operational returns among the funds, thus not achieving substantial benefits.

The biggest reason why division is unlikely to yield results is expected to be herd behavior among funds. Herd behavior in financial markets refers to the phenomenon where investors do not make independent decisions but imitate the decisions of other investors. For example, if another financial institution sells a particular stock, an investor ignores their own information about the price change of that stock and follows suit by selling it. When this occurs, asset trading and prices tend to move in one direction, increasing the likelihood of market instability.

Various studies on overseas cases where pension funds are divided and operated show that herd behavior among funds occurs seriously. Research analyzing the Dutch pension funds, which are divided by occupational sectors, and Chile's retirement pensions, privatized and operated by multiple private management companies, all show that herd behavior occurs in management regardless of the size and number of funds or pension systems. As a result, in these countries, although retirement pensions are divided and operated by multiple funds, there is little difference in asset allocation, investment behavior, and returns.

Why does herd behavior occur? Related studies suggest two main reasons. First, there is little difference in the information used by funds when making investment decisions. Management entities have the ability to access and analyze more diverse information than individuals, but the information they hold about future financial markets and economic outlooks cannot structurally differ significantly.

The more important reason is that since the operational performance of funds is frequently disclosed and compared, if a fund adopts asset allocation and investment strategies significantly different from others and performs poorly, it will face criticism from subscribers. The National Pension Fund receives more public attention and scrutiny than any other pension fund worldwide. Assuming the current fund is divided into three funds of 250 trillion won each, if one fund's operational return is 1% lower annually than the others, it means a shortfall of 3 trillion won in performance. Such a situation would likely lead to considerable criticism.

Ultimately, funds will choose similar asset allocations and management strategies to achieve similar operational returns as the best way to avoid criticism. Improving the management of the National Pension Fund, which is responsible for the public's retirement, is difficult with simple operational methods alone. As the Legislative Research Office suggested in another report, without simultaneously improving the National Pension system, fund management, and finances, securing long-term stability will be challenging.

Shin Jin-young, President of the Korea Corporate Governance Service and Professor at Yonsei University Business School