Doubts raised about new Korean rules

No one can accuse the Korean authorities of sitting on their hands over the past year in their efforts to drive domestic investment and reinvigorate the struggling local stock market.

With the benchmark Kospi index having sunk -4.4% in the past year and -10.8% over the past five years, numerous measures have been introduced, including tax incentives to encourage new pension savings and investment into foreign equity funds, greater risk allowance in existing retirement schemes and lower barriers to entry for private equity and hedge funds.

They have also revamped risk classifications for collective investment vehicles in an effort to reflect volatility more accurately and, in theory, act as a simplified guide to encourage investment.

You might think such moves would create associated benefits for Korea’s asset management industry, which has been dormant in fund-raising terms. The funds industry has seen inflows largely matched by outflows over the past three years, by Kofia data.

But while industry players welcome these moves as positive, they also question their real benefits. No one AsianInvestor spoke to saw any of these plans as a game-changer. It seems more will be needed to alter the status quo.

Excluding the wealthy
The country's Financial Services Commission is set to introduce the Korea Individual Savings Account (Kisa) from mid-March this year, with a view to providing a more comprehensive asset management vehicle for Korean households.

Customers will be able to build a portfolio of financial products with tax benefits within a threshold of W200 million ($165,000) per year for three to five years.

Yet this targets those whose annual income is less than W50 million ($41,000). In other words, it excludes high-net-worth individuals, the people who actually invest in funds.

The CEO of one asset management firm in Seoul, who asked to remain anonymous, said: “We expect some more allocation to come into mutual funds, but this is a savings account and so banks will dominate.

“People who put money into funds tend to be those with disposable income. We don’t expect much allocation from lower-income individuals. We will have to coordinate with banks to get our mutual funds included in Kisa portfolios.”

Separately, the strategy and finance ministry revised a bill last year that includes allowing tax exemption on capital gains for new funds investing more than 60% of their capital in foreign equity. This runs to end-2017, with a maximum investment of W30 million.

Asset managers in Korea had long complained that capital gains tax was discouraging domestic investors from entering overseas equity funds, even as the Kospi floundered.

But the exemption only applies to new products, and the minimum holding period is 10 years. Fund firms believe existing funds need to be included if the move is to prove meaningful.

“Now we have to prepare new products, including tax-exempt share classes for international funds, which is burdensome,” said the fund firm CEO. “I do not think a tax benefit over 10 years will be a significant factor for allocation.”

He made the point that authorities in Korea did not tax locals on capital gains for trading stocks, as occurs in North America. Koreans trade stocks because doing so is tax-free, he noted, and unless individuals have accumulated a certain level of wealth, they do not build portfolios with funds.

Driving real change?
Another adaption due to take effect in July will see funds labelled with new risk classifications, giving asset managers six months to prepare.

Currently there are five categories based purely on asset class, so equity funds have been mostly rated in the highest risk category, and fixed income in the lowest.

But from July funds will be based on exposed volatility over the past three years. If a fund records more than 25% volatility, it will be labelled 'most risky', on a sliding scale down to 0.5% for the most stable sixth bucket.

This will give investors more information and a different way to diversify. But while it is expected to help in the fund-selling process, since it is considered simple to understand and a more appropriate measure of risk, it is more likely to reduce mis-selling than to be an influential factor in investor decision-making.

Moreover, as this measure will be based on historical performance, it also carries the risk of being misleading, for example when a long-dated government bond has experienced low volatility but is faced with a drastic rise in interest rates.

“I agree that the steps being taken by Korean authorities are positive signs,” added the CEO. “They will benefit groups of people and will give investment managers more flexibility.

“But whether those benefiting are really a driving force in Korea’s financial services industry is doubtful. It is not tax that is stopping the development of Korea’s mutual fund industry or its capital markets. Of more concern is the average level of household debt and the cost of housing taking too much out of disposable income.

“In truth we do not expect the focus on investor behaviour to change as a result of these measures. Then again, maybe only market recovery can really do that.”