"Is the National Pension Fund's Profitability Being Sacrificed to Defend the Exchange Rate?" Myths and Realities of FX Hedging [Financial Microscope]

Misconceptions and Realities of Foreign Exchange Hedging According to Authorities

"The National Pension Service is sacrificing profitability to defend the exchange rate." This is a recent criticism from some quarters regarding the National Pension Service's (NPS) currency hedging. In response, the foreign exchange authorities countered that it is "not a sacrifice of the nation's retirement assets, but rather their protection." They argue that realizing gains when the exchange rate rises and securing profitability through hedging is, in the long term, the way to safeguard the nation's retirement assets.

Currency hedging refers to locking in gains or losses from exchange rate fluctuations in advance. In periods like the present, when overseas stock prices and the exchange rate move in the same direction, hedging plays a role in reducing the volatility in gains and losses that could otherwise increase without such measures. The foreign exchange authorities particularly point out that for institutional investors like the National Pension Service, which have large overseas investment assets and long investment horizons, it is crucial to secure returns in advance, making the management of exchange rate risk highly necessary.

"The Life Cycle of the National Pension Fund: A Globally Rare and Unique Structure"

The foreign exchange authorities believe that a flexible currency hedging policy is needed, taking into account the life cycle (cash flow) of the National Pension Fund. According to the Ministry of Health and Welfare's 5th National Pension Fund Financial Projection, the fund's peak accumulation is expected in 2040, reaching 1,775 trillion won. After that, it is projected to start decreasing, and by 2055, the fund could be depleted, reaching minus 47 trillion won. This projection assumes a 4.5% rate of return.

During the accumulation phase of the fund's life cycle, the expansion of overseas investments increases upward pressure on the exchange rate, while in the depletion phase, the process of selling overseas assets can increase downward pressure on the exchange rate. Analysts say that for the National Pension Service, which manages large-scale assets, exchange rate risk management is necessary to mitigate volatility over the long term.

Lee Changyong, Governor of the Bank of Korea, pointed out at a press conference held after the Monetary Policy Board meeting on monetary policy direction in November last year, that "the life cycle of the fund is a unique structure that is rarely observed in other countries managing stable asset sizes." He explained that, since the size of the NPS fund fluctuates over time and is uncertain, it is necessary to secure the actual long-term rate of return to some extent, rather than judging based on short-term valuation gains.

Governor Lee also told reporters after his New Year's address on the 2nd, "If the won depreciates when taking funds abroad, the returns in the United States (or overseas) become very high, but the opposite occurs when bringing them back," highlighting that such situations can distort not only the NPS's returns but also the foreign exchange market. He emphasized that even if book returns are high, this does not mean retirement assets grow rapidly in the short term, so after securing some gains from exchange rates, it is necessary to ensure profitability upon repatriation through various methods such as hedging.

Lee Changyong, Governor of the Bank of Korea, is delivering his New Year's address at the opening ceremony held on the 2nd at the Bank of Korea in Jung-gu, Seoul. Bank of Korea

"Large-Scale Overseas Investments: Time to Reconsider from a Macroeconomic Perspective"

Governor Lee also believes that the NPS should consider changing its asset allocation strategy toward reducing the scale of overseas investments. This is because the expansion of overseas investments by the NPS, now a major institutional investor, acts as a factor weakening the won and can impact not only other economic agents but also the domestic market itself, potentially leading to market contraction. According to the National Pension Service Fund Management Center, as of the end of October 2025, the NPS's overseas equity investments amounted to 531.7 trillion won, accounting for 37.2% of the total fund assets (1,427.7 trillion won). Overseas bond investments stood at 98.7 trillion won, or 6.9% of the total.

Governor Lee stated, "Even in the mid-to-late 2000s, I was among those who argued for increasing NPS overseas investments to diversify investment destinations, but now the scale has become too large, so the framework must change," adding, "(In this situation,) it is theoretically incorrect for the NPS to construct an optimal portfolio without considering macroeconomic effects." He emphasized that, given the structural shift with increased overseas investments by individuals and the private sector, it is time to consider what is best for the country's overall portfolio. To this end, he believes the NPS should diversify risks more through currency hedging and reduce the scale of overseas investments compared to the present.

He further explained that even overseas pension funds known to have a 0% currency hedging ratio effectively hedge currency risk by issuing dollar-denominated bonds. Governor Lee said, "Canadian pension funds are said to have a 0% currency hedging ratio, but they issue about 20% of their debt in dollar bonds, which naturally serves as a hedge," and emphasized, "There is no institution with large-scale assets that does not hedge currency risk." He also noted that the NPS's potential issuance of foreign currency bonds, currently under government review, could be a method for risk diversification.

Governor Lee stressed that the NPS's hedging strategy should become more flexible to improve exchange rate imbalances. He pointed out that the confidential criteria for triggering or lifting strategic hedges are fully exposed to the market, leading to one-sided expectations about the direction of the exchange rate.

An employee is organizing US dollars at the Counterfeit Response Center of Hana Bank in Jung-gu, Seoul. Photo by Yonhap News Agency

"Are Retirement Assets Being Held Hostage? ... Not Diversifying Long-Term Risks Is Gambling"

The foreign exchange authorities believe that the current exchange rate level is high compared to the fundamentals of the Korean economy. They analyze that foreign capital inflows due to the inclusion in the World Government Bond Index (WGBI) will act as a factor boosting the value of the won. According to this outlook, the currency hedging conducted by the NPS when the exchange rate was in the high 1,400 won range not only contributed to stabilizing the foreign exchange market by supplying dollars, but also played a positive role in partially securing the NPS's profitability in anticipation of a future decline in the exchange rate.

In retrospect, currency hedging could negatively affect the NPS's profitability. For it to contribute to returns, the decline in the exchange rate must exceed the cost of hedging. On this point, the foreign exchange authorities unanimously argue that it is inappropriate to evaluate hedging based on subsequent rises or falls in the exchange rate. They stress that currency hedging is closer to "insurance" that disperses risk by reducing sharp volatility in returns. Baek Bonghyeon, Head of the Foreign Exchange Market Team at the Bank of Korea, said, "'The focus should be on the fact that hedging locks in gains and losses from exchange rates, thereby reducing risk. If the objectives and goals sought through hedging have already been achieved, there is no need to worry about other scenarios. This is the correct understanding of currency hedging," adding, "Rather than focusing solely on foreign exchange gains and losses, it is important to evaluate the rationale for decision-making and compliance with internal guidelines."

Governor Lee also remarked, "From the standpoint of managing the fund, one might say, 'How can I, not being the government, consider all these macroeconomic impacts?' That is understandable," adding, "If a misjudgment leads to losses, responsibility is assigned, but if hedging results in favorable outcomes, there is no reward. This structure needs to be improved, and we must work together, including through the four-party consultative body, to develop a new framework that addresses this."

The foreign exchange authorities also fundamentally believe that the competitiveness of the domestic capital market itself must be strengthened by improving the domestic investment environment. They argue that the current "excessive depreciation of the won" is both a result and a symptom of supply-demand imbalances and the lack of attractiveness of the domestic market, which offers relatively weak investment incentives. However, they acknowledge that this is a mid-to-long-term challenge and that it is difficult to achieve exchange rate stability in a short period. In this regard, former Deputy Prime Minister and Minister of Economy and Finance Koo Yooncheol stated, "In the era of an artificial intelligence (AI) revolution, we plan to foster ventures and industries capable of generating higher returns than overseas markets, while also implementing policies to enhance the appeal of the Korean market, such as protecting shareholder interests and eradicating unfair trading."