Scott Kalb, former chief investment officer of Koreas
$45 billion-plus sovereign wealth fund, Korea Investment Corp.,
knows how to take smart risks. Hired by KIC in 2009, Kalb, 56,
reorganized the investment team and stabilized KICs
loss-making investment portfolio which was then worth
just $19 billion by recalibrating its approach to risk
management, diversifying its holdings and implementing a
long-term investment culture and discipline. The results have
been dramatic. Over the three years of his tenure, through
March 2012, KICs portfolio has delivered annualized
returns of 12 percent. Although Kalbs term as CIO came to
an end on March 31, he remains an adviser to KIC through June
30 and continues to work closely with his successor, Dong-ik
Lee, who previously ran KICs private markets group. In
April Kalb spoke with Institutional Investor London
Bureau Chief Loch Adamson about global investment risks and the
opportunities he sees for KIC.
What changes did you make to KICs strategic
asset allocation model when you arrived?
Kalb: We reorganized our strategic asset allocation model
around risk. Broadly speaking, we divided assets into three
categories, or risk buckets, and each category has three
sectors. The first category is growth, and we put public
equity, private equity and credit into that risk bucket, since
each of those ought to be growth drivers, depending on the
economic environment. The second category is stable value,
which we think of as providing a stable source of income,
rather than an opportunity to shoot for returns and it
also helps lower the volatility of our portfolio by delivering
good diversification in the event of any craziness in the
equity markets. We allocate government bonds, hedge funds and
cash to that bucket. The third category is for real-return
assets, and that is where we put commodities,
inflation-protected bonds and real estate.
Where do KICs strategic direct investments
The strategic investment portfolio is separate, because
its not part of the asset allocation model. Its
opportunistic. With all of those other strategies, you can make
an asset allocation plan and then work to implement it.
Strategic investing depends on whats out there in the
markets and the returns are always going to be lumpy,
which can distort your asset allocation model, so its
better to keep this strategy separate.
Do you take a different asset allocation approach
when making those investments?
We take a barbell approach. On one side, we are looking to
invest in sectors where we see a structural deficit in the
Korean economy, for example, natural resources. Those
investments help act as a hedge on the overall economy as well
as provide returns. On the other side, we invest in sectors
where we may see some synergies for Korean firms clean
technology, industrials or advanced materials, for
How do you source those opportunities?
We source them from our peer group and from the market.
Increasingly, were finding that companies are coming
directly to sovereign institutions to source capital
there is a process of disintermediation taking place, and I
think that trend is going to continue. Sovereign wealth funds
are a fairly new phenomenon, but their power and influence is
destined to grow. Companies are reaching out directly to
sovereign institutions because they not only control large
pools of capital but also have a very long-term investment
Are sovereign wealth funds increasingly likely to
partner with each other to make direct
I think partnerships are going to be the wave of the future.
We have recently teamed up with several other sovereign
institutions to make direct investments seven individual
transactions to date, representing billions of dollars. And
when you do that, you deepen your network, lower the cost
structure for everybody involved and share your know-how.
What advice would you give portfolio managers
dealing with current economic issues?
The key is to be countercyclical. You dont want to be
cavalier about it, but you want to lean into risk when it makes
sense to do so. You have to be careful, but there are terrific
opportunities out there in certain markets like Europe.
Weve seen some great, well-established European companies
priced as if they were about to go away, but theyre not.
Investing in these kinds of assets is going to make a lot of
money in five or ten years. As an investor, you just have to
have the right attributes to withstand short-term price
volatility until you get there.
Has the European debt crisis affected your use of
Traditionally, you didnt use government bonds in your
portfolio to make money you used them to provide
stability and bring in a little bit of cash flow. They were
seen as safe assets. But these days, government bonds are
sources of enormous risk: duration risk, because interest rates
are so low, and credit risk, because debt levels are so high.
Those risks are creating havoc with a lot of firms asset
allocation models, including ours. I think its less
problematic for sovereign wealth funds because they can afford
to take a very long-term view. But theres no question
that the crisis gives us a headache, as we still need and want
to invest a good portion of our portfolio in bonds.
How do you view equity investments?
This is an unusual moment to invest in equities. Its
the first time in more than 50 years that the average dividend
yield in the stock market is higher than investment-grade bond
yields, which means youre getting the capital
appreciation potential for free. Basically, investors are
getting paid to take that option risk. I recently looked at
some historical data and discovered that there was a long
period in the early part of the 20th century when this happened
previously when dividend yields were higher than bond
yields, because it was a time of successive world wars and
tremendous economic instability as the U.S. came out of the
Great Depression. But we havent seen a situation like
this since the 1950s or 1960s and now it is back again.
Our generation has never lived with this before.
What asset classes or investment opportunities are
you particularly excited about?
I think there is enormous opportunity in real estate right
now in Europe and the U.S. Over the past decade we have
seen a historic gap develop between fixed income and real
estate. For example, U.S. Treasuries went up by 65 percent
during this period of time, while U.S. home prices declined by
35 percent. I cant tell you if its the bottom of
the market in real estate, but I can tell you that the
long-term prospects for returns on government bonds or
investment-grade securities look pretty slim to me. By
comparison, real estate has been badly beaten up and looks
attractive, so I think its a natural place to look for
How do you anticipate deploying fresh capital
in public or private markets?
When I came into this organization three years ago, I did a
survey and realized that the average sovereign wealth fund had
about 35 percent of its assets in what I call nontraditional
private market strategies. We were then at zero, so my goal was
pretty clear. Since then weve put about 15 percent of our
assets into those areas, and the government has recently
approved an increased deployment of 20 to 30 percent of our
assets into alternatives and strategic investments. Dong-ik
Lee, my successor as CIO, is the perfect guy to do that because
he was in charge of private markets previously and his
appointment clearly signals where KICs emphasis is going
to be in the years ahead.