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KIC aims to control investment risk within certain limits and appropriately manage potential losses.
We have in place a risk management system that provides comprehensive control solutions for managing risk at every step, for not only the front, middle and back offices, but also corporate management.
The Steering Committee reviews and deliberates on risk management policy while the Board of Directors (BOD) allocates risk limits and establishes risk management guidelines. The Risk Management Subcommittee (under the Steering Committee) and the Risk Management Working Committee (under the BOD) arrange detailed risk management guidelines via in-depth discussions.
The Risk Management is strictly separated from the Investment Management to ensure the independence and autonomy of the risk assessment and investment monitoring processes.
KIC manages market risk, credit risk, derivatives risk, operational risk and legal risk. We adopt quantitative indicators and limits to measure each type of risk and assess and monitor each risk indicator during the investment process. When key risks exceed limits, the Risk Management Working Committee examines the issue and discusses possible solutions. To supplement quantitative analyses, we also perform various types of qualitative analyses.
Manage the risk levels of excess returns on traditional assets, including equity and fixed-income investments, based on benchmarks designated by sponsors
Designate allocation limits for external managers relative to the total net value of alternative assets and for each asset class
Monitor the degree of investment concentration by region, strategy, sector and vintage
Include securities-related credit risks and counterparty credit risks
Invest in derivatives on a limited basis to enhance returns and make portfolio adjustments
Prevent financial losses arising from risks associated with inappropriate internal processes, employees, systems and external factors
Review legal risks associated with the management of entrusted assets prior to all investments; use a post-management system to ensure protection of investor rights and mitigate legal risks
For traditional assets including equities and fixed income, KIC manages the risk levels of excess returns based on benchmarks designated by our sponsors. Public market risk is defined as the volatility of excess returns against the benchmark, and we measure, monitor and set limits using ex-ante tracking error (T/E). In 2021, the ex-ante T/E (minimum - maximum) for KIC’s total portfolio was 48~73 bps and managed within limits. The tracking error for equity was within 71~110 bps and for fixed income, 38~63 bps. A key source of alpha generation, these tracking errors are effectively allocated and managed across investment strategies.
KIC also measures and monitors indicators including Value at Risk (VaR) and Conditional VaR, which estimate portfolio volatility for the management of absolute returns from an asset allocation perspective. We conduct stress tests in preparation for various extreme situations, using not only historical scenarios, but also hypothetical scenarios involving, for example, a sudden rise in inflation or interest rates. We estimate potential losses from various angles and consider the results when making investment decisions.
To account for the limitations of econometric models, we check for risk model validity (model backtesting) and have introduced such techniques as conditional loss level prediction (CoVaR). Furthermore, we designate investment-eligible asset classes, set risk limits regarding the weights of asset classes, countries, currencies and industries as well as establish the ratios of each outsourced manager and bond duration. We also work to continuously improve our risk management system by identifying current related issues through online meetings with global institutions and more.
Lastly, we closely monitor financial market trends by reviewing key market risk factors and analyzing their implications from a risk management vantage point.
We also constantly monitor individual fund returns. If a fund underperforms the benchmark by a certain degree, we review the underlying reasons and prepare solutions. When implementing these solutions, we look at how certain factors impact not just the fund in question, but our portfolio as a whole to conduct comprehensive inspections and continuously improve our risk management process. For traditional investments, we restrict investments in countries and products with significant liquidity constraints and regularly monitor portfolio transaction liquidity.
The Risk Management Group designates allocation limits for external managers relative to the total commitments of our alternative assets and for each asset class. For diversification purposes, the group also monitors the degree of concentration by region, strategy, sector and vintage. Recently, in order to achieve a stable alternative investment portfolio, we have managed concentration risk by reducing the maximum amount of alternative investments entrusted to each GP. Of course, we review risk factors for each investment plan prior to making any investment-related decisions. For direct investments or projects with significant risk, the Risk Management Group participates in on-site due diligence with the front office and conducts a prior and independent assessment of risk factors.
Post-investment, the Risk Management Group monitors investments based on the profit and loss level of each project. Our group has also adopted and integrated a Public Market Equivalent analysis, analyses of alternative investment market indices, relative performance comparisons by vintage year and quantitative model analyses for the alternative investment portfolio using private market risk factors.
KIC classifies credit risks into securities-related credit risks and counterparty credit risks. To manage credit risks from securities, we designate the lowest grade eligible for investments based on credit ratings by Moody’s, S&P and Fitch Ratings, and set investment ceilings by issuers of corporate credit.
We manage counterparty risks by setting a minimum credit rating, selecting and managing appropriate counterparties and designating exposure limits based on credit ratings. We have also established an internal counterparty assessment system that uses such factors as counterparty credit ratings and various types of credit risk information to regularly monitor counterparty risks. In 2021, we strengthened our management process for counterparties by analyzing their transaction data and excluding those that did not meet our internal evaluation standards.
Derivatives are invested on a limited basis to enhance returns and make portfolio adjustments. To prevent excessive leverage transactions, we manage risks by designating investment-eligible derivative products and assigning position limits. For derivative financial products used in various investment strategies, we work to effectively integrate and monitor investment data by checking each counterparty’s transaction and exposure management status.
Operational risk management aims to prevent KIC from incurring financial losses arising from risks associated with inappropriate internal processes, employees, systems and external factors. KIC has developed and conducts employee self-check surveys to better control operational risk.
In terms of organizational structure, we have separated the front, middle and back offices to maintain an effective system of checks and balances. Operational processes for the settlement of accounts and accounting related to the management of entrusted assets, as well as our IT systems, are designed to ensure effective operational risk control.
To prevent and manage legal risks, KIC reviews investment agreements, investment structures and potential issues prior to all investments. We also use a post-management system to ensure our investor interests and rights.
As KIC works to diversify its alternative investment portfolio and increase the proportion of direct and co-investments, we conduct detailed and systematic legal reviews in accordance with the characteristics of each asset class and investment type.
We also analyze domestic and foreign laws and amendments for pending issues to mitigate legal risks from various angles. Recognizing the growing importance of preventing and responding to legal risks, we have expanded our pool of legal experts, provided staff with additional training and seminars and expanded information exchanges with related agencies. We are also working more with domestic law firms to contribute to the development of Korea’s finance industry.
