Strict hedge fund rules in Korea hinder market growth

He adds that the performance so far, whilst not spectacular, fits in with the fund manager’s purpose to make steady returns. “Our target rate is around 10% per year. The fixed income fund has an NAV of 1016 to date, annualised as 6.5% per year. This is the highest so far among the 17 Korean hedge funds. The fundamental and quantitative funds have an NAV of 1012, which is above average amongst the 17 funds,” he says.

Kyung-Ha Lee, head of prime service at KDB Daewoo Securities, says that in the initial stages of any market, profitability will take time. But despite the lack of quick gains, he is positive about the future. “I expect at the end of the year AUM will be $2 billion and in two to three years’ time $40–70 billion,” he says.

Pension potential

One of the high hopes for the industry is a flow of money from pension funds into hedge funds. Pension funds are typically cautious investors and Lee estimates that Korean hedge funds would need to build up a two- to three-year track record before being able to attract pension funds but he is more optimistic about this potential flow of money. The head of an international prime broker in Hong Kong echoes this view: “Onshore pension funds need to be more comfortable with that asset class in general. They don’t yet participate internationally that much where managers have more experience. They may begin to invest offshore too but there will be a portfolio allocation limit for hedge funds in general.”

Pension fund involvement may depend on hedge fund performance – and so far this has not been stellar. “The Kospi is up 12% in KRW terms since the onset of the industry in mid-December while one of the more prominent domestic hedge funds has returned 4% over the same period,” says Bennett at Barclays.

Others are even more pessimistic. “They are barely in the money. They are supposed to beat the market but they are suffering and not doing a good job as expected,” says the Korean head of equities at a bank in Seoul.

He adds that the long/short strategy is too restrictive. “My experience with hedge fund clients is that long/short strategy has already proven to be the wrong business model. Only the big hedge fund guys offshore doing multi-asset strategy such as foreign exchange have a better chance to survive but those who focus on long/short can’t.”

Last year saw the exit from Hong Kong and Singapore of many offshore funds that focused solely on a long/short strategy in a single market, which poses a bigger risk. In Korea this may be compounded by the capital gains tax on offshore investment profits, which does not encourage such investments. “This is the dark side of long/short strategy – you have to short something. But when the market is just going up you can’t short anything.”

While the Korean head of equities deems it unlikely that Seoul will morph into a new global hedge fund centre, he is nevertheless positive its emergence may whet the appetite of local institutional investors for alternative fund management in general. “Some of the local institutions that may have been reluctant to invest may find it more comfortable to bet on a local hedge fund and potentially that will act as a catalyst to invest in offshore hedge funds,” he says.

Future markets for hedge funds

China announced setting up a central securities lending repository last year, something that is already in place in Korea and is being developed by Malaysia and India.



“Malaysia and India are developing securities lending regulations and markets so the next natural step would be to allow some type of hedge funds market. India has been developing these regulations for two to three years through a central repository but the activity is very small. It needs to develop more,” says Hannah Goodwin, regional head of prime brokerage Asia-Pacific at Citi.

One stumbling block is that Malaysian regulations are prohibitive in terms of collateral. With the central depository the lender puts their shares in and the borrower receives the shares. The borrower puts collateral in the central depository but the lender doesn’t have access to that collateral so it cannot receive interest on it. In the international arena it is normal practice for the lender to receive interest on the collateral.