Fund industry eyes new opportunities
Its recent history has been a turbulent one but many valuable lessons have been learnt
By Henry G Morris
Looking back on the development of the Korean asset management market over the past 20 years, it has certainly demonstrated impressive gains in assets under management in terms of public funds, as it rose from the equivalent of just over 23 trillion won (about US$30 billion at that time) to over 250 trillion won by the end of 2009. During the past 20 years the industry has dealt with the Asia financial crisis, which resulted in the collapse of the major Korean asset managers (including the ‘big three’ of that period: Korea Investment Trust, Daehan Investment Trust and Hyundai Investment Trust) in 1999 in the wake of the collapse of the Daewoo Group, but it has also seen recovery and impressive growth and the entry of new managers, both foreign (such as Franklin Templeton and Fidelity) and domestic, such as Mirae Asset and Samsung Asset Management. While showing a reaction to the economic circumstances of the country itself, the assets under management of the Korean fund management industry have generally shown great resilience and steady growth, albeit with retrenchment at times but always a solid recovery as the Korean economy went from bust back to boom or at least stability.
When we look at the Korean market over the past 20 years, one of the remarkable achievements of the industry in general has been the increase in the number of local companies that are active in fund management as well as the entry and increasing trend in the number of foreign asset managers that have become active in Korea over the past two decades. Interestingly, although Korea joined the OECD in 1996, at that time there were no foreign fund managers active in Korea. The regulations at that time prevented foreign fund managers from entering other than by joint ventures with Korean counterparts, and so the first foreign fund manager to enter Korea via a joint venture was Franklin Templeton (actually, the merger between Franklin and Templeton had just taken place and so the actual counterpart at the time was Templeton) and this joint venture was launched in April of 1997 as Ssangyong Templeton Investment Trust Management Company.
There were some difficulties in gaining acceptance from the Korean side that the fund management market in Korea needed some improvement in terms of operating structure. For instance, James Rooney, who heads an advisory company in Korea today called Market Force, but who in those days was the CEO of the new Ssangyong Templeton joint venture, recalls that he "made history in Korean asset management by hiring Eunice Yoon, a Korean American US lawyer with years of experience on Wall Street with Citibank, as the first ever compliance officer at a fund management company in Korea." At that time the Korean fund management companies had statutory auditors but this was not a functional role in terms of modern asset management compliance practices.
It took some convincing by Mr. Rooney and the Templeton side to win over the Ssangyong side to the necessity of having a compliance officer as one of the key executives of the joint venture. The joint venture also had to deal with certain restrictions that were placed on its activities in the early days of its operations. At first, as Mr. Rooney recalls, "we were only permitted to issue equities funds based on Korean equities, and also, since banks were not permitted as yet to distribute funds, we were reliant entirely upon Korean securities companies for distribution since fund management companies were not allowed to do any direct distribution, even to institutional investors, at that time.
Of course, many changes were looming on the horizon by the end of 1997 as Korea fell victim to the Asian financial crisis and had to apply to the IMF for what was then a record bailout of over US$50 billion. The economic crisis rocked the stock market and sent it into a free fall, and Korean investors bailed out of their equities funds. But the crisis was turned to advantage by the Korean fund management industry which lost no time in taking advantage of the double digit interest rates that the IMF had mandated as a necessity to bring the Korean won’s precipitate decline to a halt and to wean the Korean conglomerates, the chaebol, away from their dependence on debt financing.
Having the ability to buy Korean government bonds at double digit yields however meant that the fund managers in the Korean market were able to issue fixed income funds at very attractive interest rates that were highly competitive versus the deposit rates on offer at Korean banks in 1998 at the height of the crisis. As a result, the industry’s assets under management began to rise sharply from 94 trillion won at the end of 1997 to nearly 199 trillion won at the end of 1998. But there was yet another disaster amidst the general economic recovery that was looming before the industry yet again.
Despite having survived the initial shock of the Asian financial crisis, the house of cards that was Daewoo Group was on a course for a titanic corporate blow up which took place in the summer of 1999 and was at that time the largest ever corporate bankruptcy ever in global corporate history. Unfortunately for the Korean asset management industry, many of the fund managers had considerable amounts of Daewoo group notes and bonds in the portfolios of their fixed income funds. Naturally, Korean investors and particularly retail investors wanted to redeem their funds when they heard that the collapse of Daewoo might mean that their funds would pay less than the expected par value if they continued to stay invested in the funds. The Korean fund management companies had not been marking the assets in their funds to market value and they usually expected to hold assets to maturity when the investors would normally redeem.
But given the expectations of the investors, the major Korean fund managers had no choice but to redeem the funds at par value, which meant that in order to provide this redemption the fund managers had to dip into their own corporate capital which quickly became insufficient. The Korean government did not want to permit the fund managers to offer limited reimbursements at current value and expected the companies to redeem at face value upon demand by investors. With their cash resources completely depleted as they paid out their investors, the ‘Big Three’ Korean investment management companies essentially became dependent upon government support and in two cases, Korea Investment Trust and Daehan Investment Trust, they were taken over by the Korean government, while the third, Hyundai Investment Trust, continued to operate under Hyundai management but was closely supervised by the Korean government.
It became clear in the wake of the crisis as the industry’s assets under management fell from previously record high levels of over 200 trillion won to a low of 137 trillion won in December of 2000, that the basic process of fund management compliance at fund management companies had failed in the case of the three major investment trust managers, Korea, Daehan and Hyundai, who had dominated the fund management business in Korea since the industry began in the early 1970s. When the Korean financial authorities, the Financial Supervisory Commission which sets financial industry policies, and the Financial Supervisory Service, which examines banks and non-banking financial companies, began to look into the complaints from the Korean public about funds sales practices, it was soon discovered that mis-selling practices were rampant in the industry.
Many retail investors claimed that funds sales staff at banks and securities companies had sold them funds by claiming that the funds were essentially as safe ‘as having the money on deposit at a bank’. Of course, in reality, there were no funds with performance guarantees and the reality was that investors were generally not aware that not only was it possible that their funds would not achieve the returns that they were promised by the distributors, but in fact the return of their principal investment was itself not guaranteed. Clearly, the funds distribution practices were seriously flawed and in need of considerable revision.
The authorities knew that the funds industry was an important one for Korea’s overall economic growth given the growing scale of funds that purchased local corporate and government fixed income securities, and equities as well, and they were determined to fix the industry’s problems in a comprehensive manner. As Rob Smith, a senior manager at Korea Investment & Securities notes, "several measures were taken in the early 2000s to try and restore investor confidence in fund managers such as the compliance officer system, mark-to-market pricing for bonds, separation of asset managers and distributors (although later reversed), and a greater number of foreign fund managers were permitted to enter the market." These and other supervisory measures, such as an insistence by the authorities that all retail investors be provided with a fund prospectus at the time of their purchase of a fund, gradually enabled the fund industry to recover and begin to expand the level of assets under management.
Also helpful was the government’s insistence that the ‘Big Three’ be sold to the private sector and not remain under direct government operating control. Hyundai Investment Trust Management was sold to the US Prudential Financial in early 2004, while Daehan Investment Trust Management and Daehan Investment & Securities were both taken over by Hana Bank in 2005, and Korea Investment Trust Management and Korea Investment & Securities were both taken over by Dongwon Securities group in 2005 as well. Interestingly, even though Dongwon was the acquiring company, it decided that the Korea Investment Trust and Korea Investment & Securities names had higher brand value than its own name and so during the process of merging it dropped the Dongwon name and retained the names of the two companies that it acquired. It should be noted that before the collapse of the industry in the wake of the Daewoo group collapse, the Big Three, Hyundai, Korea and Daehan had both fund manufacturing and distribution in-house.
But the Korean authorities decided that especially in the case of the Big Three, that fund management and distribution should be separated and operated out of companies that were legally separate entities. So shortly after the Daewoo collapse in 1999, Korea Investment Trust was split into two companies, a fund manager known as Korea Investment Trust Management Company and a securities company that was a specialist in funds distribution called Korea Investment & Securities Company. Hyundai and Daehan were split up as well, and since the merger with Hana Bank, Daehan has had a further name change to Hana Daetoo Securities and, since the Hana Bank group set up its joint venture in asset management with UBS in 2007, the fund management company has been known as UBS Hana Asset Management.
UBS was just one of the major asset managers to enter Korea as the market became more receptive to foreign participation in the 2000s, and a number of others decided to participate either via joint ventures or as independent operations. These market entrants include names such as Schroders, Fidelity, Franklin Templeton, Allianz, Macquarie, the UK Prudential (trading in Korea as PCA Asset to distinguish itself from the US Prudential Financial), as well as JP Morgan, ING, Credit Agricole, and BNP. By mid 2005 the Korean asset management market had again climbed to over 200 trillion won in assets under management and looked set to continue to grow at double digit rates. This rise in assets under management was of benefit not only to foreign fund management companies that had entered the market, but to domestic companies as well that had entered the market in the past decade. Two local companies stand out in particular for great success achieved during the first decade of the 2000s, Mirae Asset which was founded as an independent, non-chaebol company by the Korean financial entrepreneur, Hyeon Joo Park.
Mr. Park launched Mirae Asset back in 1997 as an asset advisory company but by virture of his excellent abilities in stock-picking for the equities funds that he himself was managing for Mirae, his fame grew throughout Korea and investors flocked to put money into Mirae Asset’s funds. By the end of the decade Mirae Asset had more public funds under management than any other Korean or foreign asset management that was active in the Korean market. Samsung was acknowledged to have more assets under management on an overall basis due to its position in managing segregated accounts on behalf of institutional investors. By the end of 2007, assets managed by the fund management companies that were active in the Korean market had peaked at over 312 trillion won in the public funds market and although this declined in the wake of the global financial crisis to a total of 288 trillion won at the end 2008, by the end of 2009 the industry’s assets under management had recovered back to over 312 trillion won.
The much anticipated Korean Financial Investments and Capital Markets Act that was expected to make the financial markets in Korea more robust by essentially changing the regulatory policy from a ‘positive’ system where new financial products had to be approved on a case-by-case basis to a ‘negative’ system where all types of products could be issued unless they were specifically listed on a proscribed products or activities list, did not provide the hoped-for stimulus to Korean asset management that it might have had due to the impact of the global financial crisis from 2008. Although the crisis did not undermine Korean investment management, banking or the securities industry to any significant degree and Korean financial companies did not collapse or even have extensive losses during the crisis, the effects of the crisis were felt in a reluctance of the authorities to approve certain types of products. As a result, hedge funds are almost impossible to domicile in Korea itself and instead Koreans who wish to launch hedge funds tend to locate in Hong Kong or Singapore to obtain approvals from the authorities in those jurisdictions to launch hedge funds. In time, the Korean authorities are expected to approve the operation of local hedge funds and the industry is no doubt gearing up in anticipation.
Meanwhile, the market will continue to focus on traditional types of funds inculding equities funds, derivatives based funds, fixed income funds and hybrid funds that mix various asset classes. Korean and foreign fund management companies alike tend to be positive on the prospects for the Korean market in the years ahead as the Korean economy and investment assets are anticipated to grow sharply, and major institutional investors, such as the National Pension Service which has nearly the equivalent of US$300 billion under management, are expected to grow substantially. In addition, recent changes in the Korean corporate pensions system suggest that many companies will offer a combination of a defined benefit/defined contribution type pension plan and these plans are expected to be actively managed by fund management companies in Korea. Although corporate pensions in the new pension format are only about the equivalent of US$30 billion currently, they are expected to grow rapidly during the next few years as tax incentives have been set up for companies to encourage them to covert their existing pension systems into modern managed pensions. This plus the propensity of retail investors to use funds rather than to make direct investments in Korean securities markets bodes well for the growth of asset management in Korea over the long term.