Pension Fund Allocation to a Foreign Bond ETF and a Coal IPO
Steppe Asset Management runs a mandatory pension fund with MNT 450 billion in assets and long-dated MNT liabilities. Current allocation: 70% MNT government bonds yielding 12%, 20% MSE equities, 10% cash. Internal limits: max 25% foreign-currency assets, max 10% per issuer, max 30% mining. The fund pays MNT 6 billion in benefits each month. The investment committee proposes selling MNT 76.5 billion of government bonds and using MNT 45 billion of cash to buy a 15% position in a USD global bond ETF yielding 5% and a 12% position in the IPO of Gobi Coal at MNT 1,500 per share. The fund already holds MNT 35 billion of mining equities. An analyst's DCF for Gobi Coal gives FCFF next year of MNT 18 billion, 3% growth, WACC 15%, net debt MNT 40 billion and 100 million shares. The committee asks for a recommendation.
1. Check the proposal against the fund's limits and liquidity needs. Calculate the pro forma positions and identify any breaches.
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Current. Cash is 45 billion, government bonds 315 billion, equities 90 billion, of which mining is 35 billion. The proposal buys 67.5 billion of the ETF (15%) and 54 billion of the IPO (12%), using 45 billion of cash and 76.5 billion of government bond proceeds. Pro forma. Cash falls to zero; government bonds 238.5 billion; ETF 67.5 billion; other equities 90 billion; IPO 54 billion; mining 89 billion (19.8%). Foreign currency is 15%, within the 25% limit. Mining is 19.8%, within the 30% limit. But the IPO is 12% of assets, breaching the 10% single-issuer limit. Liquidity. Cash falls to zero while benefits are 6 billion per month. The fund would have to sell assets, possibly at a discount, to pay benefits. Recommendation. Cap the IPO at 45 billion (10%) or obtain a waiver; keep at least a 5% cash/liquidity buffer; fund the foreign bond purchase partly from maturing bonds. The committee should not treat the 10% limit as a target.
2. Value Gobi Coal using the analyst's DCF and compare it with the IPO price. What is the investment recommendation?
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DCF. EV = FCFF1 / (WACC − g) = 18 / (0.15 − 0.03) = MNT 150 billion. Equity = 150 − 40 = MNT 110 billion. Per share = 110 billion / 100 million = MNT 1,100. The IPO price of MNT 1,500 implies equity value of MNT 150 billion and EV of MNT 190 billion, a 36% premium to the DCF. At 1,500 the implied FCFF yield is 18 / 190 = 9.5%, below the 15% WACC, so the price looks value-destructive on these assumptions. Sensitivity. The DCF is sensitive to WACC and growth; a 1% higher WACC lowers the value materially. Recommendation. Do not buy at 1,500 unless there is a strategic or valuation case not captured in the DCF. If buying, size below 10% and demand a margin of safety. The committee should also stress test coal prices and the MNT/USD rate.
3. Recommend an asset allocation and risk-monitoring response, including how to handle the limit breach.
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Allocation. Keep MNT assets to match MNT liabilities; use foreign bonds for diversification but hedge currency or accept the risk only within the 25% limit. A 15% unhedged USD position adds volatility without matching liabilities. Maintain a liquidity buffer and stagger bond maturities. Risk. Stress test MNT depreciation, coal price falls and a rise in benefit payments. Set rebalancing bands and a maximum single-issuer limit that includes the IPO. Governance. Document the limit breach, obtain investment committee approval for any waiver and report to the regulator if required. Do not allow the IPO allocation to exceed 10% without a formal exemption. Valuation. Use an independent valuation for the IPO and mark the ETF daily. The fund should separate the strategic allocation decision from the valuation decision and record the reasons for both.