With Kospi languishing, long-short funds rise

Korean stock investors, fed up of waiting for the Kospi index to regain its 2011 record high, are plowing cash into funds that can make money no matter which way the market heads.

Long-short funds, which bet on both rising and falling shares, have increased their assets more than ninefold in the past year to 2 trillion won ($1.9 billion), even as the nation’s equity funds shrank, according to Seoul-based researcher KG Zeroin. Individuals pulled $22 billion from stocks since the Kospi’s all-time high, as the gauge lost 13 percent and trailed the MSCI All-Country World Index by 27 percentage points as of yesterday.

Funds run by Midas International Asset Management, Truston Asset Management and Mirae Asset Global Investments have outperformed benchmark indexes for Korean shares and bonds as exports slowed and government borrowing costs rose. Opportunities to find both undervalued and overvalued companies in the nation’s $1.2 trillion stock market have increased, with a measure of the valuation gaps among Kospi members growing to the widest in more than a year.

“Investors are turning more to long-short funds as the Korean stock market isn’t in the best condition,” said Heo Pil-seok, the Seoul-based chief executive officer at Midas. “We play company-to-company and focus on valuations.”

The growth in long-short funds from 235.3 billion won a year ago corresponds with a 5 percent drop in equity mutual fund assets and an 11 percent increase in bond funds, according to Zeroin. The average one-year return of 10 funds tracked by the company with more than 1 billion won in net assets was 4.8 percent through March 5, versus the Kospi’s 2.25 percent drop and a 0.1 percent gain in the BofA Merrill Lynch Korea Government Index of debt.

The outlook for Kospi gains has diminished after most companies in the gauge reported disappointing fourth-quarter earnings, while overseas shipments last month trailed economists’ estimates amid slower economic growth in China, Korea’s biggest export market. The Kospi has traded in a range between about 2,100 and 1,750 during the past two years and on Wednesday fell 1.6 percent, the most in five weeks, to 1,932.54.

Government bonds have also lost appeal to some investors, with 1.1 trillion won of foreign outflows in the first two months this year, amid expectations that the Bank of Korea will raise its benchmark interest rate for the first time since 2011. Half of the 26 analysts surveyed expect at least one increase this year.

The yield on the benchmark three-year government bond climbed about 26 basis points in the past year to 2.87 percent, while the won gained 2.3 percent to 1,070.50 per dollar.

Long-short funds, which can wager as much as 20 percent of their net assets on falling stocks, are more insulated from market declines than traditional mutual funds that only bet on shares expected to rise, according to Kim Jin-sung, a money manager at Truston, whose $533 million long-short fund recorded a one-year gain of 9.72 percent through March 5, the highest among those tracked by Zeroin.

“Money will continue flowing into these funds as more investors realize they are the way to reduce the risk of losses,” said Kim.

While investors in long-short funds may be less vulnerable to declines in the Kospi than long-only funds, they are exposed to the risk that managers will pick the wrong stocks. There’s an 8.72 percentage point gap between the best and worst performing long-short funds tracked by Zeroin in the past year.

“I’ve met up to 10 managers of long-short funds, which I believe is a must, because you can see a huge difference in returns depending on who is running the fund,” said Ko Jae-pil, who advises clients with at least 500 million won in assets at Hana Bank’s private banking branch in Gangnam, southern Seoul. He put as much as 35 percent of client funds into a combination of long-short funds and hedge funds.

The odds of choosing the winners and losers in Korea’s stock market may be improving as the difference in valuations increases. A measure of the dispersion of price-to-book ratios in the Kospi has widened to 116 percent, the most on a monthly basis since December 2012 and up from a five-year average of 98 percent.

KB Asset Management, which oversees about $31 billion, is finding opportunities in construction companies, said BH Chung, a Seoul-based money manager of a long-short fund at the firm. The 94 percent gain in Korea Development, the best-performing stock in the Kospi Construction Index this year, compares with a 23 percent drop in Dongyang Engineering and Construction, which was halted from trading Feb. 10.

Lee Seon-keun, who runs long-short funds at Shinhan BNP Paribas Asset Management, which oversees about $34 billion, says he has underweight positions in technology and financial shares. Kospi gauges for the two industries have dropped at least 5 percent this year.

“Many investors seem to figure that the days of betting on long-only plays are gone,” Lee said. “That will apply until the market shows some kind of direction.”

Bloomberg