Management of the pension fund in Korea: Sharpe ratio as a measurement

Cheong, Mun-Kyung; Kim, Yong-Hyeon; Kim, Kyoung-Ha Article Management of the pension fund in Korea: Sharpe ratio as a measurement Global Business & Finance Review (GBFR) Provided in Cooperation with: People & Global Business Association (P&GBA), Seoul Suggested Citation: Cheong, Mun-Kyung; Kim, Yong-Hyeon; Kim, Kyoung-Ha (2023) : Management of the pension fund in Korea: Sharpe ratio as a measurement, Global Business & Finance Review (GBFR), ISSN 2384-1648, People & Global Business Association (P&GBA), Seoul, Vol. 28, Iss. 6, pp. 95-111, https://doi.org/10.17549/gbfr.2023.28.6.95 This Version is available at: https://hdl.handle.net/10419/305929 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc/4.0/ I. Introduction The size of domestic stocks in the National Pension Fund's is about 96.86 trillion Korean won as of the end of 2014. The size is rapidly increasing, and half of it is entrusted to outsourcing (or external) management companies, as of the end of 2014 1) . Received: Jul. 24, 2023; Revised: Sep. 1, 2023; Accepted: Sep. 8, 2023 † Corresponding author: Kyoung-Ha Kim E-mail: [email protected] Barberis and Schleiffer (2003) theoretically demonstrates that fund performance varies when a fund is invested with a different goal. The National Pension Investment Guidelines established by the fund management committee in Korea specify that internal (or direct) investment should be aimed at passive management, whereas outsourcing (or external) investment must be aimed at active investment. The committee also specified that the benchmark of 1) The National Pension Service has been reluctant to release the recent data. Due to this limitation, the latest data is from 2014. GLOBAL BUSINESS & FINANCE REVIEW, Volume. 28 Issue. 6 (NOVEMBER 2023), 95-111 pISSN 1088-6931 / eISSN 2384-1648∣Https://doi.org/10.17549/gbfr.2023.28.6.95 ⓒ 2023 People and Global Business Association GLOBAL BUSINESS & FINANCE REVIEW www.gbfrjournal.org1) Management of the Pension Fund in Korea: Sharpe Ratio as a Measurement Mun-Kyung Cheong, Yong-Hyeon Kim, Kyoung-Ha Kim† D ivision of Business, Hanyang Cyber University, Seoul, Korea A B S T R A C T Purpose: This study criticizes the existing benchmarks of the national equity fund specified by the National Pension Service and proposes alternative benchmarks. Design/methodology/approach: First, this study investigates whether the existing benchmarks returns are affected by the value and momentum factors. Second, we examine the effects of different factors on the benchmark returns of internal and outsourcing investments. Third, we propose three benchmarks by including the value factor and/or momentum factor. Finally, the Sharpe ratios of return-to-risk are used to measure these proposed benchmarks compared to the existing benchmarks. Findings: First, the existing benchmarks of internal and outsourcing investments are associated with value and momentum factors, which have been observed in many other countries. Second, the Sharpe ratios of the three proposed benchmarks - value oriented, momentum oriented, and value & momentum oriented - are always better than the existing benchmarks. Third, the Sharpe ratio of the value oriented benchmark is better than that of the momentum oriented and value & momentum oriented benchmarks. Finally, the Sharpe ratios are better with increased investment weights of value and/or momentum. Research limitations/implications: This study uses the Sharpe ratio to measure the return-to-risk relationship. There could be other measures to capture the relationship. Originality/value: This is the first research to analyze the national pension equity fund with proposed benchmarks in the Korean market. Keywords: National pension fund, Benchmark, Factor investing, Sharpe ratio ⓒ Copyright: The Author(s). This is an Open Access journal distributed under the terms of the Creative Commons Attribution Non-Commercial License (https://creativecommons.org/licenses/by-nc/4.0/) which permits unrestricted non-commercial use, distribution , and reproduction in any medium, provided the original work is properly cited. GLOBAL BUSINESS & FINANCE REVIEW, Volume. 28 Issue. 6 (NOVEMBER 2023), 95-111 96 domestic stocks is the KOSPI, that of internal investment is the KOSPI200, and that of outsourcing investment is the composite index of KOSPI and KOSDAQ100, respectively 2) . The purpose of this study is to analyze both the appropriateness of the existing internal investment and outsourcing investment benchmark through return-to-risk analysis and to propose enhanced benchmarks. For this, we research a literature study on the theoretical basis of internal and outsourcing investments. We then analyze both the existing benchmarks of internal and outsourcing investment of domestic stocks while discussing the need to improve benchmarks. Finally, we propose the new benchmarks, and show that these are superior to the existing benchmarks. The rest of this paper proceeds as follows. Section II reviews the previous literature. In Section III, we present data and methodology. We report empirical results for proposed benchmarks in Section IV. Section V concludes this paper. II. Literature Review A. Agency Problem in Outsourcing Fund Pension funds generally operate pension assets by hiring outsourcing (or external) fund managers. External management has an agency problem with the owner, where the principal is the asset owner who entrusts the asset to the fund manager, and the agent is the fund manager who has been entrusted with the asset management. Since the National Pension Service (NPS) entrusts the management of stocks, bonds and alternative assets to fund managers, the NPS becomes the owner and external fund managers become agents. The role of NPS is to select asset managers who are specialized in a single asset class of stocks, bonds, or alternatives. Thus, asset allocation decisions are 2) KOSPI stands for Korea Stock Price Index, and KOSDAQ stands for Korean Securities Dealers Automated Quotations. made in two stages. Specifically, after the NPS allocates funds to the different asset classes, managers of these different asset classes decide how to allocate the capital given to them. The two-stage process could generate the agency problem in the investment horizon. The investment horizon of the fund managers is relatively short since they are compensated on an annual basis. The NPS, in contrast, has a longer investment horizon. The agency problem arises because the NPS acts in the best interests of the beneficiaries, while the managers wish to maximize their own annual compensation. Binsbergen, Brandt, and Koijenn (hereafter BBK, 2008) show that an optimally designed benchmark improves the alignment of incentives between the principal and the agent, and mitigates the agency problem of two-stage decentralized investment management. The design of an investment mandate could be very important to solve the agency problem. Specifically, Ang (2014) argued that the agency problem can be alleviated through the design of appropriate benchmarks. He advocates that factor benchmarks can induce fund managers to perform better than benchmarks by appropriately changing the weight of factors (market timing) or exercising their ability to select stocks depending on the economy. The factor benchmarks also play a role in risk sharing between fund managers and asset owners. It is known that the fund managers' skill can be divided into two dimensions of market timing and stock selection (e.g., Kacperczyk et al. (2014); Shin et al. (2021)). The risks of the market and factors are allocated to the owner, and the risks of stock selection and market timing are allocated to the fund manager, and hence the portfolio risks can be distributed between the owner and the agent. This argument strongly indicates that stock market indexes cannot be appropriate benchmarks for investment management, and the market indexes must be replaced by factor benchmarks or rebalancing benchmarks. In conclusion, benchmarks such as market indexes are not appropriate for alleviating the agency problems related to external (or outsourcing) investment Mun-Kyung Cheong, Yong-Hyeon Kim, Kyoung-Ha Kim 97 management. Instead, factor benchmarks containing management strategies and directions can be better benchmarks that align the interests of fund managers and asset owners. We argue that the existing benchmarks should be modified to style benchmarks which can obtain both the value premium and momentum premium and propose three benchmarks. We then analyze the return-to-risk analysis of the proposed benchmarks for internal and outsourcing investments of the national pension assets in Korea. With our proposed benchmarks, we show higher returns and lower risks, and hence improved Sharpe's ratio. BBK (2008) presents a theoretical model that analyzes the difference between internal investment and outsourcing investment. Internal investment can form an optimal portfolio by considering the expected return of all assets and the covariance between assets at the same time; while outsourcing investment first considers strategic asset allocation (equity/bond or asset allocation of stock and bonds) and then forms an optimal portfolio for each asset. Therefore, outsourcing investment creates a diversification loss that does not exist in internal investment; so outsourcing investment forms a portfolio with lower performance for risk than internal investment does from the perspective of overall funds. In addition, the interests of the principal (the committee) and agent (outsourcing fund managers) are different. The committee prioritizes the interests of the fund, while the outsourcing investment managers develop a portfolio in the interests of their own compensation. Moreover, since the risk propensity and investment horizon of the committee and the fund managers are different, the agency problem occurs, resulting in diversification losses. Benchmarks restrict the investment behavior of outsourcing fund managers and induce the managers to invest in accordance with the goals of owners. Specifically, in the absence of benchmarks, the fund manager's goal is to maximize the absolute value of the outsourcing fund. Whereas, when benchmarks are given, the goal becomes to maximize the relative value compared to the benchmark. In other words, when benchmarks are not given, the fund managers value absolute returns on assets whereas when benchmarks are given, they value relative returns compared to given benchmarks. In addition, the composition of the portfolio varies greatly depending on the risk aversion tendency of the fund manager, in the absence of benchmarks. Specifically, if the fund manager of bonds is risk tolerant, he tends to increase the weights of bonds with credit ratings BBB or lower in the bond portfolio in the absence of bond benchmarks. On the other hand, if the fund manager is risk averse, she tends to increase the weights of bonds with a high credit ratings AA or higher in the bond portfolio. This is not a desirable investment pattern from the perspective of the principal. In contrast, if a bond benchmark exists, the risk of a bond portfolio is measured as risk relative to the benchmark (active risk or tracking error), and hence fund managers form the same weights as the benchmark to avoid the risk. In other words, the fund manager tries to constitute a portfolio in accordance with the owner's interests. Even if bond managers pursue active risk, bonds are invested in accordance with the weights of bond benchmarks. Therefore, the fund managers are more likely to make decisions that match the interests of the principal (i.e., benchmark-oriented decisions) in the presence of benchmarks. BBB (2008) compares the objective function and optimal investment weights without a benchmark to those of with a benchmark. 1. Objective function and optimal investment weights without a benchmark - Objective Function:        - Optimal Investment Weights:           ′    where  : the coefficient of relative risk aversion.  : the asset managers 1, 2, and principal.   : the portfolio value at the end of the investment GLOBAL BUSINESS & FINANCE REVIEW, Volume. 28 Issue. 6 (NOVEMBER 2023), 95-111 98 horizon.   : the weights of asset manager  (value stock and growth stock for stock manager; AA bond, BBB bond and government bond for bonds manager).  : the (myoptic) weights of asset managers.   : the minimum-variance weights. Due to the two-stage decision-making process described earlier, the optimal portfolio of outsourcing investment is an inefficient portfolio with higher risks and lower returns than internal investment. In internal investment, the number of assets is 2k+1 (the number of stocks, bonds, and cash), and investments are made in consideration of their covariance. However, in outsourcing investment, each asset manager invests in the number of k assets. Therefore, the portfolio risk of outsourcing investment is greater than that of internal investment. 2. Objective function and optimal investment weights with a benchmark - Objective Function:                - Optimal Investment Weights :                  ′    where  : the weights of benchmark  (value stock and growth stock for stock benchmark; AA bond, BBB bond and government bond for bonds benchmark) The committee can minimize diversification losses of outsourcing investment by constructing optimal benchmark  . The fund manager's investment weights can be matched with the committee's optimal investment weights by evaluating performance related to benchmark and paying performance-based compensation. In other words, by designing outsourcing investment benchmarks appropriately, the committee can match the pension fund's investment strategy with the fund manager's investment goals. In conclusion, appropriate benchmarks of outsourcing investment play an important role as a means to align the pension fund's long-term goals with the fund manager's short-term investment goals. B. Factor Investing 1. CAPM Factor investing is investment into stocks considering risk factors, and factor explains the return-to-risk relationship of an asset. Therefore, factor investing is a stock investment that reflects the characteristics of risk factors which affect returns. The first factor model can be the capital asset pricing model (CAPM). Stock returns are determined by the risk premium for stock risk, which in CAPM refers to the relationship between market portfolio and stock movements, and is measured in beta. Stocks with higher beta than market beta can expect higher returns than market returns, while stocks with lower beta than market beta can expect more stable returns than market returns. Therefore, in CAPM, a factor to consider is market beta, and factor investing is an investment strategy that obtains a market risk premium by associating a portfolio with a market beta. The CAPM can be said to be a one-factor model. 2. Fama and French (1993) three factor model Fama and French (1993) explains stock returns have three factors: market, size, and value/growth. They introduced the size factor. Small-capitalization stocks tend to achieve higher returns than largecapitalization stocks, even after eliminating other risk factors. Therefore, investors who invest in small-cap. stocks gain a size premium. This phenomenon was discovered by Banz (1981), and Fama and French include this effect in their model. This represents the difference in returns between small-capitalization and large-capitalization companies and is expressed as Small stocks Minus Big stocks (SMB). The SMB factor is, in general, the stock performance of smallcap. stocks is superior to that of large-cap. stocks. Mun-Kyung Cheong, Yong-Hyeon Kim, Kyoung-Ha Kim 99 In the meanwhile, Berk, Green and Naik (1999) argued that firm value is determined by the company's current assets and investment options, and CAPM does not sufficiently reflect the value of the second corporate investment option. When managers exercise investment options, firm value increases, so the value stock factor acts as a separate risk factor from market risk of the CAPM. Zhang (2005) advocates that value companies possessing a large proportion of buildings and machinery cannot properly dispose of them when the economy suffers, while growth companies possess low corporate restructuring costs because they consist of mostly software and young people. Thus, value companies are riskier compared to growth companies, and higher risk premiums are required for the stocks. The scholars argued that value stock investors should be long-term investors waiting for the recovery of the economy, and short-term investors are less likely to make profits using the value premium for this reason. Fama and French (1993) also introduce High book-to-market stocks Minus Low book-to-market stocks (HML), which represents the difference between the portfolio return of companies with large book value to market capitalization and that of companies with small book value to market capitalization. It refers to a strategy of purchasing value stocks and selling growth stocks. The HML factor is that, in general, value stocks perform better than growth stocks. The Fama and French (1993) three factor model 3) is as follows.             3. Carhart (1997) four factor model Carhart (1997) developed a four-factor model by adding momentum factors to the Fama and French (1993) three factor model described earlier. The 3) Yun & Kim (2022) also used the Fama and Frecnch model to analyze the relationship between distress risk and the stock returns of firms. momentum strategy is an investment strategy that purchases stocks which have risen in the past six or twelve months (winners) and sells stocks which have fallen in the past six or twelve months (losers). The momentum strategy predicts performance by comparing winners with losers at a specific point in time. It advocates that stocks which have risen in the past are relatively more likely to increase in the future than stocks which have fallen. This momentum premium was discovered by Jegadesh and Titman (1993). Carhart (1997) four factor model 4) is as follows.             Daniel and Moskowitz (2013) compare the returns of winners, losers, market portfolio, and risk-free bonds, and find a momentum effect showing performance in the order of winners, market portfolio, risk-free bonds and losers. They also find that momentum strategies often have short-term reversals. In general, the size (SMB) premium is much less than the value (HML) and momentum (UMD) premiums in almost every country nowadays, so the size premium has disappeared. It is believed that the size premium effect may be the result of data mining (Alquist et al.(2018)). The excess return on stock investment (alpha, α ) can be decomposed into the fund manager's ability, SMB, HML, and UMD factor premiums. However, since the benchmark of internal investment is simply designated as a composite index of KOSPI200 and that of outsourcing investment is designated as a composite index of KOSPI and KOSDAQ100, factor premiums could not be properly reflected in the internal and outsourcing investment benchmarks. The reason is that the composite indexes of the KOSPI200, KOSPI, and KOSDAQ100 are market indexes which do not reflect factor premiums. Ou-Yang (2003) advocates that the market index benchmarks do not 4) The Carhart model was also used to investigate national pension fund performance (e.g., Cheong et al. (2020)). GLOBAL BUSINESS & FINANCE REVIEW, Volume. 28 Issue. 6 (NOVEMBER 2023), 95-111 100 induce the fund managers to act in the interests of asset owners. Ang (2014) also argues that the fund's operational reference portfolio needs to be established, and this reference benchmark should be an index reflecting factor premium. Therefore, fund managers should take a stock trading strategy that exceeds the reference benchmark and should be evaluated based on that benchmark. To this end, the fund committee should reflect the factor premium in the benchmark by determining the market beta, size factor beta, value beta, and momentum beta in the reference benchmark. C. Factor Investing, Passive Investing, and Active Management Factor investing can be represented as an intermediate stage between market index investment and active management as shown in Figure 1. It is invested by fund managers with the aim of achieving more excess return than the factor benchmarks do. Factor investing is similar to index funds in that it can be passively invested around the style index. Factor investing also could be a part of active management in that it analyzes and invests into new factors. The differences between active management and factor investing are as follows. The active management seeks diversification of management by hiring fund managers with stock selection and market timing capabilities. The committee uses investment strategies through strategic asset allocation and the selection of fund managers. It also pursues more excess return (alpha) compared to the benchmarks, which relies on fund managers' stock selection and market timing capabilities to achieve alpha. In addition, it employs many outside experts as fund managers to contribute to diversity. In the meanwhile, factor investing pursues investment diversification through designing various factor indexes. The committee presents a factor index to the fund manager to achieve higher returns and lower risks than the market portfolio. Factor investing could be a part of active management because the excess return compared to the factor benchmark is considered active investment return. In addition, the committee can hire internal fund managers at a lower cost than external fund managers, and can also hire outsourcing fund managers. III. Data and Methodology A. Data According to the National Pension Investment Guidelines, domestic stock investment is classified as internal (or direct) investment and outsourcing (or external) investment. The former is for a passive style while the latter is for an active style. The following data were used to analyze whether the internal investment benchmark and outsourcing investment benchmarks of the NPS were effectively designed to the intended characteristics of fund management: daily and monthly data of the benchmark indexes of internal investment and outsourcing investment from 2002 to 2014 as well as the SMB, HML, and UMD indices of FnGuide. The stock data set is provided by Fn-Guide, a financial data provider in Korea. According to the Fama-French method, stocks listed on the KOSPI and KOSDAQ markets are ranked at 50%/50% based on market capitalization at the end of June of each year during the sample period. We created three groups of 30%/40%/30% of stocks in each market Figure 1. Factor investing,k passive investing, and active management Mun-Kyung Cheong, Yong-Hyeon Kim, Kyoung-Ha Kim 101 size group based on the book value of net assets divided by the market value at the end of December of the last year. For the six portfolios in total, the weighted average returns for each portfolio are calculated by holding one year. The SML (small minus big) portfolio returns are the differences in average returns for the three small and three large portfolios, and the HML (high minus low) portfolio returns are the differences in average returns for the two small and two large book-to-market portfolios, based on the return data of the six portfolios. We calculated the return of momentum factors following Carhart's methodology. Three groups of 30%/40%/ 30% were generated based on the stock returns over the past 11 months between t-12 month and t-2 month. The equally weighted returns for each portfolio were calculated by holding one month t. The momentum factor of the month t is the difference between the average return of the top 30% portfolio with high past performance and that of the bottom 30% portfolio with low past performance (Cheong et al.(2020)). As explained earlier, the committee of NPS specified that the benchmarks used were domestic stocks as the KOSPI, internal investment as the KOSPI 200, and outsourcing investment as the composite index of KOSPI + KOSDAQ 100, respectively. This is shown in Table 1. B. Excess Returns of Internal Investment and Outsourcing Investment Benchmarks Table 2 shows the excess returns of internal investment and outsourcing investment benchmarks (BMs) compared to the KOSPI, respectively. Since outsourcing investment began in 2007, the internal investment period was divided into overall periods starting with 2007 to compare outsourcing investment. The average excess return of the internal investment benchmark is 0.01% per month and the standard deviation is 0.584% per month for overall periods from January of 2002 to December of 2014. The average excess return of the outsourcing investment benchmark is -0.021% per month and the standard deviation is 0.187% per month, while the average excess return of the internal investment benchmark is -0.018% per month and the standard deviation is 0.640% for periods from January 2007 to December 2014. As a graphical presentation of Table 2, Figure Category Benchmark index Remarks Domestic stock (total) KOSPI (including dividends) Internal investment KOSPI200 (including dividends) Outsourcing investment Composite index of KOSPI (including dividends) and KOSDAQ100 Weighted average by market capitalization Table 1. Stock benchmark Index specified by the fund management committee Internal investment BM minus KOSPI (Jan. 2002~Dec. 2014) Outsourcing investment BM minus KOSPI (Jan. 2007~Dec. 2014) Internal investment BM minus KOSPI (Jan. 2007~Dec. 2014) Average 0.010% -0.021% -0.018% Median -0.008% -0.015% -0.052% Maximum 2.174% 0.416% 2.174% Minimum -1.425% -0.499% -1.425% Std. dev. 0.584% 0.187% 0.640% No. of obs. 156 96 96 Table 2. Excess return of internal investment benchmark and outsourcing investment benchmark compared to domestic stock benchmark GLOBAL BUSINESS & FINANCE REVIEW, Volume. 28 Issue. 6 (NOVEMBER 2023), 95-111 102 2 presents the cumulative returns of internal and outsourcing investment benchmarks compared to domestic stock benchmarks of KOSPI for different periods, respectively. Panel A. Cumulative excess returns of internal investment benchmark (Jan. 2002~Dec.2014) Panel B. Cumulative excess returns of outsourcing investment benchmark (Jan. 2007~Dec.2014) Panel C. Cumulative excess returns of internal investment benchmark (Jan. 2007~Dec.2014) Figure 2. Cumulative excess returns of internal investment benchmark and outsourcing investment benchmark compared to domestic stock benchmark Mun-Kyung Cheong, Yong-Hyeon Kim, Kyoung-Ha Kim 109 KOSDAQ100 with changing investment ratios from 95%/5% to 60%/40%. Again, we observe that the results of Panel C follow the same pattern as those of Panel A and Panel B. That is, first, the Sharpe ratio of three proposed benchmarks (value oriented, momentum oriented, and value and momentum oriented) improves compared to the existing benchmark's Sharpe ratio of 0.055. Second, the Sharpe ratio of the value oriented benchmarks is highest except in the case of the 95%/5% investment weight. Third, the Sharpe ratios are better with increased investment weights of value and/or momentum. Overall, the results of Table 10 indicate that the more oriented against value or momentum, the higher the return and the lower the risk, and thus the higher the Sharp ratio. Based on the results, we cautiously recommend the existing benchmarks be replaced with our proposed benchmarks. V. Conclusion The fund management committee of NPS divided the national pension domestic stock investment into internal investment and outsourcing investment for diversity. The committee also determines that the domestic stocks benchmark is the KOSPI, the internal Panel A. Sharpe ratio of proposed benchmarks to existing benchmark of KOSPI Existing benchmark of KOSPI Three proposed benchmarks weights ① value oriented ② momentum oriented ③ value & momentum oriented 0.110 95%/5% 0.121 0.116 0.119 90%/10% 0.134 0.123 0.128 80%/20% 0.162 0.137 0.150 70%/30% 0.196 0.153 0.177 60%/40% 0.236 0.169 0.209 Panel B. Sharpe ration of proposed benchmarks to existing benchmark of KOSPI200 Existing benchmark of KOSPI200 Three proposed benchmarks weights ① value oriented ② momentum oriented ③ value & momentum oriented 0.111 95%/5% 0.123 0.117 0.120 90%/10% 0.135 0.124 0.130 80%/20% 0.135 0.124 0.130 70%/30% 0.198 0.154 0.178 60%/40% 0.237 0.171 0.210 Panel C. Sharpe ratio of proposed benchmarks to existing benchmark of KOSPI+KOSDAQ100 Existing benchmark of KOSPI+KOSDAQ100 Three proposed benchmarks weights ① value oriented ② momentum oriented ③ value & momentum oriented 0.055 95%/5% 0.061 0.064 0.061 90%/10% 0.073 0.067 0.070 80%/20% 0.095 0.081 0.089 70%/30% 0.122 0.097 0.111 60%/40% 0.153 0.113 0.138 Table 10. Sharpe ratio of proposed benchmarks GLOBAL BUSINESS & FINANCE REVIEW, Volume. 28 Issue. 6 (NOVEMBER 2023), 95-111 110 investment benchmark is the KOSPI 200, and the outsourcing investment benchmark is the composite index of KOSPI + KOSDAQ 100. The outsourcing management can generate an agency problem. The investment horizon of the outsourcing fund managers (the agent) is relatively short since they are compensated on an annual basis. The NPS (the principal), however, has a longer investment horizon. BBK (2008) shows that an optimally designed benchmark better aligns the incentives between the principal and the agent. Ang (2014) argues that the agency problem can be alleviated through the design of appropriate benchmarks. The researchers argue that benchmarks such as market indexes are not appropriate to alleviate the agency problems. Instead, factor benchmarks containing management strategies and directions can act as better benchmarks that could align the interests of fund managers and asset owners. This paper advocates for three new benchmarks to propose the existing benchmarks be modified to obtain the value premium and momentum premium. It designs two ways to propose benchmarks. The first way is to include the value and momentum factors into the domestic stock benchmark (KOSPI). The second way is to include the value and momentum factors into the internal investment (KOSPI200) and outsourcing investment benchmarks (KOSPI+ KOSDAQ100). This study then performs return-to- risk analysis of the proposed benchmarks for internal and outsourcing investments. We find three important results. First, the Sharpe ratios of three proposed benchmarks (value oriented, momentum oriented, and value and momentum oriented by 50%) are better compared to those of existing benchmarks. Second, the Sharpe ratio of value oriented benchmarks is the most improved among the proposed benchmarks. Third, the Sharpe ratios improve with increasing investment weights of value and/or momentum. The importance and implications of this study are as follows. Above all, it is important to establish an investment strategy in consideration of momentum and value factors. In other words, it is necessary to create benchmarks using momentum factor and value factor rather than simple benchmarks (KOSPI, KOSPI200) based on market capitalization, and then present fund managers investment guidelines based on created benchmarks. In addition, when assessing the performance of a fund manager, the investment performance tiled in momentum and value factors should be evaluated separately from that of the manager's stock selection ability. This study uses the Sharpe ratio to measure return-to-risk relationship. There could be other measures to capture the relationship. This may pose as a limitation to this research and is left as a challenging task to future research. Acknowledgments This paper is based in part on the research project of management of outsourcing pension fund at the National Pension Research Institute. References Alquist, R., Israel, R., & Moskowitz, T. (2018). Fact, fiction, and the size efffect. Journal of Portfolio Management, 45(1), 1-6. Ang, A. 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