NPS Needs a System to Keep Hedge Funds in Check

Some insiders of the National Pension Service (NPS) point out that the company should exercise its voting rights differently from activist hedge funds, including Elliott Management, even if it adopts the so-called stewardship code, a guideline that encourages institutional investors to exercise their voting rights and be more actively involved in the management of the companies they invest in.

The Voting Rights Committee for the NPS, which is currently reviewing the final draft of the stewardship code, is planning to submit a soft landing stewardship introduction plan to the Ministry of Health and Welfare this week.

More than one member of the Voting Rights Committee claimed on May 8 that the NPS needs to introduce a device to keep in check foreign hedge funds, which are bent on making short-term profits.

One member said, “The NPS borrowed the stewardship code system from Britain, which was the first to introduce it. But the British model doesn’t reflect the characteristics of the NPS, which invests a large proportion of its assets in domestic stocks. When foreign investors with minority stakes join hands and excessively submit proposals to put pressure on domestic companies, the NPS can suffer damage. So, we are considering measures to prevent this.”

The Voting Rights Committee needs to determine the scope of assets subject to the stewardship code. It is considering not applying it to the assets under management of NPS-entrusted asset management companies. It is also considering prohibiting the Korea Corporate Governance Service (KCGS), which prepared the stewardship code system, from engaging in the business of offering consultations on exercising voting rights and putting other voting right consulting companies under the supervision of the Financial Supervisory Service.

However, it is not easy to come up with compulsory measures as the stewardship code is a norm that is not enforced by law but followed by institutional investors voluntarily. This is why some experts say the NPS should have more leeway in exercising its voting rights and not be strictly bound by a guideline. For instance, under the current guideline, the NPS have to support Elliott’s proposal that Hyundai Motor Group introduce cumulative voting to allow foreign directors to be elected to the boards of its affiliated companies.

This is because such proposals in principle provide a higher rate of return by extending stockholders’ rights. In particular, after having been burned by the merger between Samsung C&T and Cheil Industries, the NPS feels pressure when it has to make a decision that goes against its voting guideline. In fact, the prevailing sentiment in the Voting Rights Committee and the NPS is that they should strictly follow the voting guideline.

Market experts point out that the NPS should have its own standards to exercise its voting rights in a way that fits its characteristics, since it has a different purpose from hedge funds like Elliott.

Elliott is an activist fund that aims for higher short-term profits, while the NPS is more like a passive fund that seeks long-term profits. In addition, the NPS is an institutional investor which has the highest ratio of assets invested in domestic stocks among major pension funds in the world. When the NPS exercises its voting rights in compliance with its new guideline based on the stewardship code, without taking into consideration its distinct characteristics, it could end up in helping Elliott earn short-term profits and being saddled with side effects.

Some foreign pension funds and large asset management companies prohibit investment in hedge funds as their investment philosophy differs from that of hedge funds. The California Public Employees' Retirement System (CalPERS), the largest pension fund in the United States, withdrew more than 4 trillion won (US$3.71 billion) of investment in hedge funds in 2014. The London Pension Fund Management Service in the United Kingdom also stopped investing in hedge funds because of their high commissions, opaque management and low long-term earnings rates.

Many studies overseas show that when hedge funds aggressively exercise their stockholder's rights, the shot-term rate of returns tends to rise but not the higher long-term rate of returns. On the other hand, the long-term yield rate goes higher when institutional investors, including pension funds, that seek long-term earnings rates exercise their stockholder's rights with moderation.

In the United States, hedge funds and big individual investors aggressively exercise their stockholder's rights by submitting shareholder proposals and taking derivative actions, while pension funds tend to behave more prudently and make strategic choices, for instance, by withdrawing shareholder proposals after talking with management.

Song Hong-sun, a senior research fellow at the Korea Capital Market Institute, said, “Many large foreign funds, including Vanguard and BlackRock, mainly make a passive investment. They often oppose hedge funds’ attempts to expand dividends and intervene in management to maximize short term profits. The NPS should also maintain its balance as a long-term investor and determine individual issues on its own rather than being bound by the guideline on voting rights.”