South Korea's National Pension and Foreign Currency Hedging Strategies: Balancing Stability and Returns

South Korea's National Pension Service (NPS), one of the world's largest pension funds, has emerged as a pivotal player in the country's foreign exchange (FX) strategy. With 58% of its $896 billion in assets invested overseas, the NPS's demand for U.S. dollars has directly contributed to the won's depreciation, prompting government intervention to stabilize the currency while safeguarding the fund's investment returns. This article examines the NPS's evolving role in FX management, the effectiveness of historical hedging programs, and the potential of dollar bond issuance to reconcile macroeconomic stability with long-term pension performance.

The NPS as a Currency Stabilization Tool

The NPS's overseas investments have created structural imbalances in South Korea's FX market. As of August 2025, the fund's $396 billion in dollar-denominated assets have exacerbated downward pressure on the won, which weakened by 7.73% in the first half of 2025 alone. To counteract this, the government has coordinated with the NPS to explore measures such as increasing its hedging ratio from 0% to 10% of overseas assets, potentially injecting $52.1 billion into the FX market. This strategy aims to boost dollar supply and reduce speculative volatility, though it risks diluting the NPS's returns in a strong dollar environment.

The NPS also operates a $65 billion foreign exchange swap line with the Bank of Korea (BOK), allowing it to access dollars without directly impacting open markets. This tool has been extended to the end of 2025, reflecting the government's commitment to managing liquidity risks while preserving the fund's flexibility. However, critics argue that such interventions may limit the NPS's autonomy, as hedging decisions become entangled with broader macroeconomic objectives.

Historical Hedging Effectiveness and Trade-Offs

From 2020 to 2025, the NPS's hedging programs have shown mixed results. In 2024, the fund achieved a 15.00% annualized return, driven by strong performance in global equities (34.32% return) and domestic stocks. However, the won's depreciation against the dollar-reaching 1,470 KRW/USD in late 2025-highlighted the tension between currency stability and investment gains. For instance, the NPS's global fixed-income portfolio underperformed in H1 2025, posting a -5.13% return as the weakening won eroded returns on dollar-denominated assets.

Historical data reveals a recurring challenge: while hedging can stabilize the won, it often reduces the NPS's exposure to a strengthening dollar. For example, in 2024, the fund suspended strategic hedging to avoid limiting returns during a period of dollar strength. This underscores the difficulty of balancing short-term currency defense with long-term investment goals.

Dollar Bond Issuance: A Dual-Edged Sword

To address FX volatility, South Korea has raised its offshore bond issuance ceiling to $5 billion for 2026, aiming to bolster reserves and support the won. This strategy complements the NPS's hedging efforts by diversifying dollar inflows and reducing reliance on the fund's market interventions. However, the effectiveness of bond issuance depends on global market conditions. For instance, the NPS's own dollar bond sales could inadvertently increase domestic dollar supply, indirectly supporting the won while generating yield for the fund.

The government's broader $20 billion U.S. investment program further illustrates this duality. By channeling capital into dollar assets, the initiative aligns with the NPS's long-term return objectives but risks exacerbating won depreciation unless hedging measures are synchronized.

Quantifying the Balance: Stability vs. Returns

The NPS's hedging strategies have had measurable, though uneven, impacts. In H1 2025, the fund's 4.08% money-weighted return was bolstered by domestic equities (31.34% return) but offset by losses in global fixed income as the weakening won eroded returns. Meanwhile, the won's 7.73% decline against the dollar during the same period underscored the cost of not hedging during periods of dollar strength.

A key metric is the NPS's hedging flexibility: it can increase its hedging ratio to 15% during volatility, potentially stabilizing the won by up to $30 billion in liquidity. However, this comes at the expense of reduced returns when the dollar is strong-a trade-off that policymakers must weigh against inflationary risks from a weaker won.

Conclusion: A Delicate Equilibrium

South Korea's experience with the NPS highlights the inherent tension between currency stability and investment performance. While expanding hedging and dollar bond issuance can mitigate won depreciation, these measures must be carefully calibrated to avoid undermining the NPS's returns. The government's consultative approach-with the NPS, BOK, and Health Ministry-signals a recognition of this complexity, but long-term success will depend on structural reforms to address FX imbalances.

For institutional investors, the NPS's strategies offer a case study in balancing macroeconomic priorities with fund performance. As the won's volatility persists, the coming months will test whether South Korea can achieve a sustainable equilibrium between these competing objectives.