Risk Management

Overview
The main objective of risk management at KIC is to keep risks that arise in the process of managing entrusted assets within a given range. The Steering Committee has the authority to review and make final decisions on risk management policy, while the Board of Directors (BOD) oversees execution of the policy including the setting of risk limits.

The responsibility for formulating detailed measures lies with the Risk Management Subcommittee under the Steering Committee and the Risk Management Working Committee under the BOD. Risk management activities are carried out by the Risk Management Division. Strict separation of the Risk Management Division and the Investment Management Division enables independent risk review and monitoring. The Compliance Officer oversees matters pertaining to internal control and ethics management.
 

KIC classifies risks into the categories of market risk, credit risk, derivatives risk, operational risk, and legal risk. For each risk category, quantitative indicators are selected to measure the risks and appropriate limits are set. Each risk indicator is monitored during the actual investment process. If key risks increase beyond the set limits, the Risk Management Working Committee examines the issues and considers countermeasures. The risk management process also includes qualitative analysis to complement the constraints of quantitative tools.

 

Market Risk
KIC manages traditional assets in accordance with the benchmarks designated by the sponsors. As such, the market risk of traditional assets is basically defined as the volatility of return in excess of the benchmark. KIC uses ex-ante tracking error to measure market risk and sets ex-ante tracking error limits. As of the end of 2013, the ex-ante tracking error was 95-100bp for the aggregate portfolio, 55-70bp for equities and 65-70bp for fixed income.
 

Moreover, to counter increasing volatility in the financial markets, KIC also uses other tools including Value at Risk, stress tests and tail risk management. Along with pre-designation of eligible investments, limits are set for weightings for each asset class, currency and sector / industry as well as durations. We also monitor individual portfolios to keep their returns from falling below a certain level relative to the benchmarks.

Various steps are taken to effectively manage risks associated with alternative investments. They include participation in due diligence by the departments responsible for risk management and legal affairs, the setting of various limits, periodic valuation of investments, and quantitative risk analysis.

Credit Risk
KIC broadly classifies credit risk into credit risk arising from the fixed income holdings in our portfolio and counterparty credit risk. We designate the lowest grade eligible for investment based on credit ratings given by Moody’s, S&P and Fitch Ratings, and set investment ceilings by issuer for corporate fixed income. To manage counterparty credit risk, we set the lowest permissible credit rating of the counterparty, designate eligible counterparties, and set the exposure limit according to the counterparty’s credit standing. In addition, we use indicators such as the CDS spread, market-implied rating and financial stress index.

Derivatives Risk
KIC invests in derivative products for effective risk management and investment purposes. To manage the associated risk, we designate derivative products eligible for investment, invest within prescribed position limits, and place restrictions on transactions involving excessive leverage.

Operational Risk
As a manager of public funds, KIC has established processes and systems to manage various kinds of operational risk. KIC classifies operational risk into people risk, process risk associated with transaction error and inadequate internal control, and technical risk related to modeling and systems error. We make continuous efforts for workflow automation, process improvement and capability enhancement in order to minimize the possibility of human error and fraud.

In addition, KIC designates custodian banks for the safekeeping of entrusted assets. Along with the custodial function, the custodian bank carries out activities related to accounting, tax payments and refunds, settlement of trades, and interest and dividends received. Separately from the Investment Management Division, the KIC back office reviews and controls the operation risk management system, especially with related to the execution order, transaction verification and reconciliation implemented by the custodian banks.

KIC maintains an independent reporting system that checks for compliance with internal risk management rules and sponsors’ guidelines.