The decision by South Korea's National Pension Service (NPS) to suspend its portfolio rebalancing is emerging as a significant driver of heightened volatility in the country's stock and foreign exchange markets.
Barclays economist Bum Ki Son noted in a new research report that while the NPS's suspension of its rebalancing rules has delivered excess returns for the fund, the cost has been a notable amplification of market fluctuations. "Pension funds are typically seen as stabilizers in financial markets. However, the NPS's adjustment to its operational rules has instead turned it into an amplifier of volatility," he wrote.
This warning comes as a key measure of volatility for the KOSPI 200 index hit a record high earlier this week, with the South Korean stock market experiencing sharp swings between extreme price movements.
In response to a Bloomberg inquiry, South Korea's Ministry of Health and Welfare—the government body overseeing the NPS—stated that the fund's management committee's earlier decision was aimed at enhancing the fund's profitability and stability, and took into account broader efforts related to the fundamental development of the South Korean capital market. The ministry also stated that "the Barclays report relies considerably on excessive assumptions, and its analysis of causality has not been fully verified."
The Cost of Volatility Behind Excess Returns
The NPS is South Korea's largest pension fund and the biggest shareholder in its stock market. In January, the fund temporarily exempted itself from mandatory rebalancing rules that are triggered when asset allocations deviate from preset ranges. The management committee warned at the time that continuous rebalancing during a period of high market volatility—particularly when domestic stocks exceed their target allocation range—could have an outsized impact on local equities and the foreign exchange market.
However, Barclays's counterfactual analysis suggests the cost of this decision is significant. Bum Ki Son estimates that if the NPS had maintained normal rebalancing operations, its return on domestic stocks would have been 11.1% by the end of May. The actual return reached 21.7%—showing a clear excess gain, but also a substantial rise in portfolio volatility. He points out that because the NPS did not sell during market overheating and did not buy during declines in March and through June, its absence directly exacerbated volatility in the KOSPI.
Official data shows the NPS's domestic stock return for the first quarter was 21.7%, with total assets reaching 1,526.1 trillion won (approximately $1 trillion) as of March 31. Meanwhile, as the KOSPI has surged about 90% year-to-date, becoming one of the world's best-performing major benchmarks, the NPS last month significantly raised its target allocation for domestic stocks while simultaneously cutting its target for overseas equities.
Pressure on the Foreign Exchange Market
Barclays's report also highlights the profound impact of the NPS decision on the Korean won. Bum Ki Son wrote that while the NPS initially cited foreign exchange market pressure as one reason for pausing rebalancing, this decision has instead placed "significant pressure" on the FX market.
"We believe the NPS's rebalancing exemption effectively transferred its rebalancing needs to foreign investors, which in turn translated into excess dollar demand driven by equity outflows from the South Korean FX market," he wrote.
Data supports this view. So far this year, global funds have been net sellers of $78.7 billion worth of South Korean local stocks. Analysts attribute much of this outflow to passive selling triggered after holdings in market leaders like Samsung Electronics Co Ltd and SK Hynix Inc surged above forced allocation limits following significant gains. The won earlier this month fell to its lowest level since 2009, despite government pledges to curb excessive volatility. Authorities this week announced plans to crack down on speculative FX trading, helping the won post its largest weekly gain in over a year.
Rebalancing Resumes in July: Execution is Key
With the NPS planning to resume rebalancing operations in July, market focus has shifted to the intensity of its execution. Bum Ki Son noted, "The extent to which the NPS strictly adheres to rule-based rebalancing will be an important factor influencing the won's trajectory."
However, the NPS has already signaled a softer approach—it has lowered the daily cap for its rebalancing activities. Barclays believes this could keep volatility in the domestic stock market and pressure on the won at elevated levels.
It is worth noting that the core drivers behind the South Korean stock market's record-breaking rally this year—the artificial intelligence boom and the resulting demand for memory chips—remain intact. However, the accumulation of margin debt and geopolitical shocks stemming from conflict in the Middle East have repeatedly triggered sharp volatility. The KOSPI's 24% monthly gain in January set a record, only for it to be broken by a 31% monthly surge in April. The premium investors pay for options to hedge against market volatility has also climbed to historic highs. Against this backdrop, whether the NPS's rebalancing mechanism can truly return to normal will be a key indicator for South Korean market stability in the second half of the year.
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