A robust corner of Asia's hedge fund industry lies in South Korea, where the government, faced with the familiar global problem of an ageing population, has actively encouraged the development of alternatives to boost pension and other investment returns.
As the world's 13th largest economy and eighth largest exporter, with a population of almost 50 million and OECD-level GDP per capita, Korea is enjoying private and corporate wealth. The country emerged from the global financial crisis of recent years with small but positive growth of 0.2%, but the government's commitment to growing their economy resulted in growth the following year of 6.1%. It doesn't entertain high levels of public debt either with debt currently sitting at 23% of GDP.
As of 2011, according to analysts from Deloitte Consulting in Seoul, assets under management from Korean institutional investors grossed approximately $1.5 trillion, and despite the recent global financial crisis, the total AUM of Korean institutional investors displayed average growth of 12.1% over the last five years. Deloitte's believes that due to Korea's ageing population, pension capital will continue to accumulate, acting as a driving force to the asset growth of Korean institutional investors.
Kenneth Kang is the principal with Deloitte Consulting, a service provider in Korea for the global alternative investment industry, working with 30 institutional investors from the local asset management industry, responsible for some $900bn in investment, and advising them on where to deploy their capital. He says: "The government sees this is the one area that they want to focus on due to the fact that a lot of institutional investors need to diversify their portfolios."
But it is increasingly challenging for Korean institutional investors to meet their target returns with traditional assets of domestic stocks and bonds only. Deloitte's says: "Since returns from these traditional assets are rendered insufficient due to heightened stock market volatility and low interest rate for domestic fixed income products, Korean institutional investors feel growing pressure to restructure their investment portfolios."
And alternatives have taken their place centre stage. Amendments to The Enforcement Decree of the Capital Market Consolidation Act saw Korea launch its first hedge funds in December, 2011. The nascent industry started out with $140m under management across 12 funds. By August 2012, the industry had displayed stellar growth of five times the initial assets up to $650m and, at the time of writing, Kang reports assets are at $800m. The funds are largely long/short equity and working under a regulatory regime which limits leverage, derivative use and shorting.
"They're not really achieving performance" Kang says. "Obviously looking globally at the history and dynamics of the hedge fund industry, the reason it was so successful is the talent - the smartest guys in the financial services industry moved to the hedge fund industry because of the lucrative compensation structures. In Korea, the history is not similar – it's an involuntary emergence of the hedge fund industry as opposed to voluntary and because of that, there is a lack of talent."
However, Kang reports that in the last two months the government has given a green light to three new hedge fund managers, one of whom is highly regarded in the Korean asset management industry, and they are performing well so far. "We are moving out of involuntary territory" says Kang.
"Hedge fund managers need to get their heads around diversified investment strategies" Kang says, "because there are different capital market structures here, for instance Event Driven in the US market is based on Chapter 11, a unique US structure which American hedge fund managers can take advantage of but which is not available in Korea."
Kang believes that over the longer term, long/short equity managers will prevail, as they have in Hong Kong, Singapore and Japan. In terms of servicing hedge funds in Korea, Kang says that attention needs to be paid to the capital market infrastructure as it is currently very different from that in the US or the UK. "Leverage and re-hypothecation is needed in Korea in order to achieve returns" Kang says. "The hedge fund market here is short of fuel."
Deloitte's reports that the majority of funding for new hedge funds comes from seed capital from subsidiary firms but the investor pool is showing signs of diversification from increasing investments made by high net worth individuals and institutional investors. 2011 saw Korean institutional investors' allocation to alternative investments sitting at less than 2% of the total assets under management. Deloitte's analysts say: "As the Korean hedge funds fulfil the track-record requirements for domestic institutional investors such as pensions and insurance companies, it is expected that we will see more of institutional money flowing into the Korean hedge funds."
Domestic Korean institutions have certainly adopted alternatives. The Korea Investment Corporation (the KIC) is the sovereign wealth fund of Korea with assets of some $50bn under management. In an interview with Asia Pacific Intelligence, Minjun Kim, Senior Investment Manager, Investment Strategy Group, Head of Hedge Funds for KIC, reports that currently the KIC has roughly about $1.3 billion invested in hedge funds.
At the time of writing, the KIC is not allowed to invest in the domestic Korean hedge fund industry and observers feel that it won't until the local funds have proved themselves capable of good and steady returns.
But non Korean hedge funds are included because, Kim says, "Hedge funds are categorized as a "stable asset class", which aims to generate stable and continuous returns like fixed income". Kim describes the KIC portfolio of hedge funds as very diversified. "As long as it generates stable and enough returns, it is good with us" Kim says.
A previous Chief Investment Officer and Deputy CEO of KIC, Scott Kalb, was recently interviewed on Opalesque TV. Kalb describes his relationship with hedge funds, from the point of view of a sovereign fund investor, as a partnership. "It's no longer about giving a couple of guys some money, they make some money and then they give it back to you" he says. In Korea, the partnership theme is strong. Deloitte's analysts say: "Korean institutional investors are extremely relationship-based, which makes it harder for global hedge funds to directly penetrate the investor pool in Korea."
There is also, of course, fear to contend with. We reported in Asia Pacific Intelligence's November issue that Jun Kwang-woo, CEO of Korea's $340 billion National Pension Service, is beginning to consider the possibility of investing in hedge funds. But caution, driven by market sentiment, and a general perception that hedge funds are risky and speculative is holding the process up.
Deloitte's analysts say: "In committing their capital to global hedge funds, the Korean institutional investors demand proper risk management and trustworthy reference. In attempting to carry this out independently, many renowned global hedge funds found themselves unsuccessful in building significant relationship with the Korean investors. The Korean institutional investors have abundant source of capital they can allocate to global hedge funds, but the challenge lies in offering them with the needed security to raise their money".
This article was published in Opalesque's Asia Pacific Intelligence our monthly research update on alternative investments in the Asia-Pacific region.