Hedge Funds in Korea: Industry Overview (1)
A rising market with regulatory support and positive sentiment
Majority of foreign investors find it surprisingly difficult to penetrate the Korean hedge fund market due to its limited accessibility and availability of information in foreign language. The series, “Hedge Funds in Korea” is published to tackle such inefficiency and analyze Korean hedge fund industry in-depth in multiple dimensions.
While the global hedge fund industry has been continuously expanding since 1991, establishment of hedge fund entities was prohibited in South Korea due to tightening regulatory control over the financial market until late 2011. However, earlier that year, the South Korean National Assembly purposefully proposed a financial regulatory revision to boost the domestic market growth by promoting cash inflow into local investments, including the ones for hedge funds. The proposal sequentially got approved and enacted into law in Dec 2011, giving birth to the very first kinds of Korean hedge fund.
Ever since its inception, Korean hedge fund industry constantly showed significant growth in market size in terms of aggregated AUM thanks to favorable regulatory support and high demand from not only institutional but also retail investors. In addition, the regional hedge funds also outperformed the global hedge fund market.
- The market grew from USD $12.3bn (Dec 2017) to $ 23.0bn (Aug 2018) and at a rate of 96.6% CAGR since 2011
- Number of active hedge funds increased to 1358 nos. in Jun 2018 from 765 nos. in Dec 2017
- Korean hedge funds generated 12.89% average return in 2017 compared to Eurekahedge Hedge Fund Index return of 8.3%
i) Market Performance
Above are the tables summarizing last 5 years of market performance indices. The performance of the Korean hedge funds is assessed by two measures: Korean Hedge Funds (by The Bell) and Eurekahedge Korean Hedge Fund Index.
a) Korean Hedge Funds (by The Bell): “The Bell” is the largest Korean hedge funds specialized database & media established in 2017. Constitutes of 214 underlying funds. However, the data is only available biannually from 2017 onward.
b) Eurekahedge Korean Hedge Fund Index: Relatively low credibility as it constitutes of 7 underlying funds only, compared to its other indices such as China (70 funds) and Japan (65 funds)
Cross-regional and cross-sectoral comparative analyses were carried out using other regional indices, which are also enclosed in the tables. Please note that period prior to 2017 shall not be discussed as no statistically reliable information is available.
The background information and key findings are summarized below :-
- During Jan — Jun 2018, the Korean hedge funds managed to generate 3.94% of positive return when both the MSCI World Index and KOSPI dropped by -0.66% and -5.73% respectively. During the same period, the Chinese and Japanese hedge funds showed performance of -0.08% and -2.46% each
- In 2017, Korean hedge funds generated 12.89% of positive return. However, this is lower compared to the MSCI World Index and KOSPI which grew by 23.07% and 21.76% respectively and the Chinese and Japanese hedge funds which returned 29.80% and 12.91% each
- Korean hedge funds outperformed the global hedge fund indices by HFR and Eurekahedge. However, their ability to constantly outperform the market is yet to be proven
ii) Fund Statistics and Capital Flow
Ever since the first inception of the Korean hedge funds in 2012, the corresponding market has been one of the fastest expanding markets in the world. The total aggregated AUM of Korean hedge funds increased from USD $12.3bn in Dec 2017 to USD $23.0bn in Aug 2018, which nearly doubled in 8 months. The number of the funds also increased roughly in line, from 765 nos. to 1358 nos. during the same period.
The major driver for the growth can largely be divided into two: the regulatory support and rising sentiment. Over past years, the Korean government continuously showed numerous efforts to relieve fund-related regulations and entry barriers to promote the growth of the domestic financial market, which shall be discussed in later section. On the other hand, the global investors began to turn their attention to the Asian hedge fund market because of not only the higher growth rate but also greater structural inefficiencies, which can often be turned into so-called “alpha” by fund managers.
Until few years ago, the investors had been primarily focused on the Chinese and Japanese markets when forming their Asian portfolios due to greater accessibility and size. However, it can be observed from the graph above the rising sentiment among foreign investors toward the Korean hedge fund market, especially since early 2016. In fact, the foreign investors showed greater interest in the market even compared to the domestic ones, as can be seen from the statistics below.
- Since Dec 2012, 97.5% of the monthly offshore capital flow was positive on a net basis. This is greater than that of 77.78% from onshore capital flow
- Historically the offshore capital showed significantly lower outflow in percentage terms compared to that of onshore capital. In Aug 2018, onshore to offshore capital ratio for the inflow was 3.0x while that for the outflow was 14.1x
Prior to 2014, the major strategies employed by Korean hedge funds were fixed income and fundamental equity L/S. In 2018, the fixed income strategy survived, which is easily understandable considering that Korea has one of the largest bond markets in Asia, but the equity strategy did not despite of its global popularity. Also, the proportion of funds under multi-strategies increased significantly. There are two key drivers behind this shift in market trend: the diminishing market growth and escalating competition.
Korea enjoyed several years of high economic growth as in 2014, topping 3% every year. However, the growth rate began to deteriorate despite of expansionary monetary policy, and it became increasingly difficult for the hedge funds to generate satisfactory result only through fundamental equity strategy. In addition, the market itself became increasingly competitive due to immensive inflow of newly established funds and more sophisticated investors, who demanded higher level of unique portfolio management techniques — or alpha. Consequently, greater number of funds began to utilize their regional expertise to take more active approaches and diversify their approaches, which explains the widespread of multi-strategies within the Korean hedge fund market.
it is also notable that the fund with event driven strategy is rapidly increasing with similar rationale to that for the multi-strategies.
Thank you for the reading. In the following series of “Hedge Funds in Korea”, a breakdown of top performing Korean hedge funds and key regulatory revisions shall be discussed.
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