[At-Risk Public Offering Funds] ① 2.7% Return, but Half of It Goes to Fees... Nothing Left

Public Funds Shrink Amid Competition from ETFs and Private Equity Funds
Activation Needed to Resolve Market Undervaluation and Achieve Balanced Growth

[Asia Economy Reporter Lee Seon-ae] After the COVID-19 pandemic unleashed a flood of capital, the domestic public offering fund market, which seemed to be warming up, froze solid during last year's stock market downturn. As of the end of last year, the assets under management (AUM) of public offering funds stood at 283.1 trillion KRW, a 9.3% (28.9 trillion KRW) decrease compared to the end of 2021.

The reason is simple. Returns are minimal, yet total fees continue to be charged. As of the end of last year, among 3,299 domestic equity funds, less than 5% (161 funds) recorded positive returns over one year. The average return of public offering funds over the 10 years from 2010 to 2019 was only 2.7%. Despite this, investors must pay total fees around 1.5% annually (based on offline C-class equity funds).

Although it may seem like a burden, the positive functions of public offering funds cannot be ignored. Public offering funds are useful for resolving the undervaluation phenomenon of the Korean stock market (Korea Discount), breaking through and stabilizing the KOSPI 3000, and balancing the stock market. Since public offering funds are actively managed, they can act as a lever to lift the index when the market is sluggish. In contrast, Exchange-Traded Funds (ETFs), which have recently become popular, are passive and track indices, making it difficult to change market direction.

ETF Market Growing Annually with Many Products and Low Fees

However, individual investors known as Donghak, Seohak, and Junghak ants have turned away from frustrating public offering funds and instead trade stocks directly or invest in ETFs. ETFs that track indices such as stocks, crude oil, and gold are sold by securities firms but are listed and traded on exchanges like regular stocks. Compared to public offering funds, ETFs have lower fees and can be traded freely like stocks. They offer diversification effects comparable to public offering funds and come in a variety of products. Additionally, intense competition among asset management companies has led to fierce fee reduction battles.

As a result, the net asset value of ETFs, which was around 40 trillion KRW at the end of 2018, exceeded 90 trillion KRW as of the 14th of this month. Particularly, ETF investments based on retirement pensions are increasing, and bond ETFs are gaining popularity, attracting institutional investors as well. Kim Jun-seok, Senior Research Fellow at the Korea Capital Market Institute, explained, "ETFs, which offer diversification effects at low costs and excellent convenience and accessibility, have recorded a high annual growth rate of 33% since their introduction in Korea." The asset management industry expects the ETF net asset value to soon reach 100 trillion KRW. Kim Chan-young, Head of Digital ETF Marketing at Korea Investment Trust Management, predicted, "Given the current growth trend, the domestic ETF market size will grow to around 200 trillion KRW by 2027."

Rapidly Growing Private Funds Also Threaten Public Offering Funds

The growth of the private fund market is also a factor threatening public offering funds. According to the Korea Financial Investment Association on the 16th, as of the end of last year, public offering fund assets under management were 283.1 trillion KRW, down 9.3% (28.9 trillion KRW) from the previous year-end. In contrast, private fund assets increased by 9.3% (48.3 trillion KRW) during the same period, reaching 568.1 trillion KRW.

Private funds are funds that raise and manage capital privately from 49 or fewer investors. They target institutional investors or high-net-worth individuals and pursue high returns with high risks. Public offering funds, on the other hand, raise and manage capital publicly from 50 or more unspecified investors. They target individual investors and pursue moderate returns with low risks.

The first year when the net asset value of public offering funds fell behind private funds was 2016. At the end of 2015, the net asset value of public offering funds was 213.7869 trillion KRW, which slightly decreased to 212.2156 trillion KRW by the end of 2016. In contrast, private funds surged from 199.7984 trillion KRW to 250.1793 trillion KRW during the same period. Since then, public offering funds stagnated while private funds showed unstoppable growth. The net asset value of private funds rapidly increased from 199.7984 trillion KRW at the end of 2015 to 566.0961 trillion KRW at the end of last year.

Low Returns but Management Fees Must Be Paid

The biggest reason individual investors turned their backs on public offering funds is the poor returns. Traditionally, public offering funds were considered the best investment option for moderate risk and moderate returns. Investors expected stable returns by entrusting professionals. However, reality was different. The average return of public offering funds over the 10 years from 2010 to 2019 was only 2.7%. Especially, as of the end of last year, only 161 out of 3,299 domestic equity funds recorded positive returns over one year. Despite such minimal returns, investors must pay annual fees even after deducting front-end loads.

Researcher Kwon Min-kyung of the Korea Capital Market Institute pointed out, "The biggest cause of the public offering fund market slump is poor returns, along with issues in fund managers' stock selection and investment timing capabilities." Since public offering funds are mostly actively managed, fund managers' discretionary decisions greatly affect investment performance. Kwon analyzed, "The average performance of active funds failing to meet benchmark indices likely disappointed many investors, causing them to exit."

Another factor contributing to the sluggish public offering fund market is the rigidity of the sales market. Public offering funds can be purchased online but are mainly sold through banks and securities firms, which receive sales commissions. The level of sales commissions is uniformly set according to the fund's collective investment regulations. Therefore, all sales companies must charge the same sales commission for the same fund and class. This structure prevents any price competition among sales companies.

The rigidity of the sales market is also related to the high sales commissions of public offering funds. Large financial companies with established positions have strong incentives to strategically promote funds with high sales commissions. To encourage large financial companies to sell more funds, asset management companies need to set high sales commissions.

Public Offering Funds Must Be Revived for Balanced Stock Market Growth and Undervaluation Resolution

Financial authorities, the Korea Financial Investment Association, the Korea Exchange, and other related securities institutions have rolled up their sleeves to revive the stagnant public offering fund market. Why bother reviving public offering funds despite their flaws and shortcomings? Experts agree that the liquidity of public offering funds, a representative form of indirect investment, is necessary to resolve Korea's stock market undervaluation (Korea Discount), break through and stabilize the KOSPI 3000, and balance the stock market.

A research center head at a securities firm explained, "Long-term indirect investment funds must flow steadily and stably into the stock market to provide momentum for the domestic stock market to escape undervaluation." At the end of last year, securities firms strengthened their retail businesses to revive public offering funds. They reorganized and reshuffled personnel to enhance individual customer services. A representative example is Yoon Ji-ho moving from the Ebest Securities Research Center to become head of the retail business division. Hana Securities changed its research center into an independent organization directly under the CEO, not under the WM group. Researcher Kwon Min-kyung said, "Public offering funds are considered safe indirect investment products. If the slump continues, a vicious cycle of performance decline → loss of trust → net capital outflow may lead to market collapse."

Public offering funds are also necessary for balanced stock market growth. A senior official at the Korea Financial Investment Association explained, "ETFs are passive and track various indices, so they are unlikely to change market direction when the market is sluggish. However, public offering funds are actively managed and can serve as a catalyst to lift the market."

Experts say improving returns is essential to revive the public offering fund market. Researcher Kwon Min-kyung emphasized, "Asset management companies must make self-help efforts to enhance returns through improved management capabilities." Building customer trust through long-term return improvement is urgent. She added, "Strengthening overseas asset investment capabilities and internalizing asset allocation capabilities are also essential to compensate for low expected returns in the domestic market." Professor Yoon Seon-jung of Dongguk University's Business Administration Department also stressed, "If fund returns are not improved, incentives for market growth will diminish. Causes of underperformance compared to benchmarks must be analyzed to improve returns."

Professor Ko Kwang-soo of Pusan National University's Business School advised at the online policy symposium "Diagnosis and Revitalization of the Slump in Equity Public Offering Funds," "The number of funds should be reduced and their size increased, and it is necessary to develop global fund products with relatively low volatility through high diversification." Researcher Kwon Min-kyung emphasized, "Measures to promote competition should follow, such as encouraging new entrants who provide simple sales services without separate advice or solicitation, or expanding sales channels that offer low-cost automated advice."