With net flows plunging almost 13 times over 2020 to KRW5.3 trillion (US$4.9 billion), and assets under management (AUM) declining to 3.2% in 2020, the scandal-hit private funds market in Korea will need to take stock and work hard to regain investors’ favor.

Between 2011 and 2020, Korea’s private funds market recorded a compound annual growth rate of 15.7%, reaching KRW407.1 trillion in AUM. The rapid expansion was mainly due to several deregulations in the hedge fund and private equity segments, the most significant of which was in 2015, when investors’ minimum investment thresholds for hedge funds were lowered. Given the wider pool of investors managers could tap on, it was not surprising to see them jump on the bandwagon, especially during a time of low interest rates.

Furthermore, securities companies, which hold the biggest distribution marketshare in the public space, were given the green light to manage private funds in 2016, prompting them to shift their distribution focus to the latter. With assets growing 22.7% to KRW242.4 trillion, the private funds industry exceeded the public funds market in 2016.

However, the rapid rise of private funds was halted in the second half of 2019, following Lime Asset Management’s freezing of fund redemptions on several of its derivatives-linked securities due to liquidity issues in October that year. Banks and securities firms were then found to have mis-sold these products, which led both the Financial Services Commission (FSC) and Financial Supervisory Service (FSS) to request that banks stop the sales of highly complex financial products whereby investors risk losing up at least 20% of their principal in November.

The steady stream of news of managers and securities companies suspending fund withdrawals from various private funds, the latest being Shinhan Investment Corporation in October, further eroded investor trust and significantly impacted their confidence in the private markets. Meanwhile, distributors started re-evaluating their plans. Cerulli understands that banks now are more selective in onboarding private funds and less active in promoting them. Securities companies have also shifted their focus from private funds to stock brokerage, following investors’ increasing preference for direct equity investing. Indeed, a 3.2% and 28.8% slide in banks’ private fund sales was seen in 2019 and 2020, respectively, while securities companies registered smaller private fund sales growth of 7.0%, compared to double-digit growth in the previous year.

Following the scandal, Korean financial regulators have implemented changes to various rules governing the private fund market. Among them, the FSC has raised the minimum investment amount in hedge funds from KRW100 million to KRW300 million. It has also implemented standards for the classification of “highly complex” investment products, including product complexity, the amount of possible loss, and whether the investment products are listed.

“The private funds market is unlikely to see the same strong double-digit growth which it enjoyed prior to 2020,” said Della Lin, senior analyst with Cerulli. “Tighter regulations, banks’ and brokers’ shifting focus away from private funds, and investors’ preference for direct equity investing will weigh on prospects, at least in the short term. Nevertheless, greater regulatory supervision as well as increased investors’ and market players’ awareness of the risks of complex products should bode well for the industry.”