Korea fund houses betting on pensions for salvation

The pre-global financial crisis model for selling mutual funds in Korea is broken and it might require the expansion of corporate pensions before it revives, says Thae Khwarg, CEO at SEI Asset Korea.

Lipper data shows that the local funds industry suffered net outflows of $26.3 billion in the fourth quarter of 2010.

Although this is often attributed to retail investors selling equity products into a rising stock market (in order to break even from loss-making funds), Khwarg notes that the damage is even worse in the fixed-income arena.

The bond market in 1998, just before the country was consumed by the Asian financial crisis, stood at W173 trillion ($154 billion at today’s exchange rates), versus only W44 trillion ($39 billion) today.

Total Korea mutual fund assets were $260 billion as of December 2010, according to Cerulli Associates, growing just slightly thanks to market appreciation barely outpacing net redemptions in Q4.

Meanwhile, international equity products have suffered the worst outflows, including the Bric and single-country funds for markets such as China, India and Vietnam.

Until 2009 these products were sold with abandon, but not with much consultation or advice. Banks and brokers were especially keen to sell aggressive (i.e. high-fee paying) equity products and complex structured products (many of which blew up,including the infamous ‘Kikos’ favoured by corporate clients).

Since then, new regulations have imposed a strict, even onerous, process of adducing product suitability for retail investors. Between unhappy investors and the new regulatory regime, the industry will find it difficult to rely on the old asset-gathering tactics of yore.

However, fund executives should not throw in the towel. First of all, the stock market looks attractive, according to Khwarg, and strong performance in the market will inevitably revive peoples’ animal spirits.

Although 2011 may not prove as strong as 2010 from an earnings perspective, the market still looks attractive based on valuation metrics such as price-to-earnings and price-to-book ratios. Low interest rates will continue to make risk assets more attractive, relative to bank deposits. And, as the country ages, the need for a more thoughtful wealth-management industry will only grow.

Inflation is a threat to Korea’s economy, but growth is strong enough to allow the Bank of Korea room to keep prices under control. This will also likely flatten the yield curve in the short term but steepen it later this year, making longer-duration bond holdings more attractive.

But to realise the industry’s potential may ultimately rely on Korea’s nascent corporate pensions regime to evolve more towards defined-contribution type plans. Currently among most large companies, strong labour groups pushed for defined-benefit plans. But companies will be eager to shed some of these liabilities, and a strong stock market may convince more people to take the plunge into defined-contribution plans.