Once-lowly RCFs attract a following

An investor, who wished not to be named, was recently advised by his broker to invest in a reverse convertible fund (RCF).

Last year, he received the same advice and invested 30 million won ($27,775) in an RCF. From the 1.35 million won in profit he made from the six-month investment, he only had to pay 230,000 won in income tax.

“Last year, I was introduced to the RCF, which has a similar structure to equity-linked securities and invested it in as a way to diversify my portfolio,” said the investor. “I’m considering making the same investment, as I enjoyed a tax reduction.”

RCFs, which almost became nonexistent after they first appeared in 2008, are gaining unexpected popularity - particularly with wealthy investors - as tax regulations on financial investments became tighter this year.

Instead of levying income tax on earnings from financial investments that amount to 40 million won or more, this year the ceiling fell to 20 million won.

A tax rate of between 6 percent and 38 percent will be applied to anyone who makes 20 million won or more from long-term deposits, corporate bonds, stock dividends, equity-linked securities, overseas funds and other financial investments.

Although RCFs have a similar structure to equity-linked securities in that they invest in underlying indices, the tax levied on RCFs is less.

“One could say the RCF is an equity-linked security managed by asset management companies,” said Lee Hyun-kyung, an official at Mirae Asset Global Investment.

The RCF promises a guaranteed level of return, unless the indices fall more than 30 percent. In that case, it is called a knock-in and investors can lose their principal.

The RCF is seen as a high-risk, high-return investment.

The difference between RCFs and equity-linked securities is in the tax rate.

In the case of equity-linked securities, when an investor makes 1 million won in dividends, he has to pay 14 percent, or 140,000 won, in taxes. But in the case of RCFs, the investor can exclude profits from the security exchange from taxation. The funds are designed so that 75 percent of the returns come from stocks, commodities and futures. So if an investor makes 1 million won, he pays the 14 percent in taxes only on the 250,000 won, which works out to 35,000 won.

Unlike other investments, including deposits, equity-linked securities or bonds, roughly 75 percent of the profit made from RCFs is tax free.

Furthermore, investors don’t have to pay redemption fees after 90 days. In the case of equity-linked securities, an investor can liquidate the investment before it reaches maturity only by paying a fee equivalent to 10 percent of its value during the first six months and 5 percent of its value thereafter.

On the other hand, RCF investors can liquidate at any time with no additional fees, and they can extend their maturity date at no additional charge.

With such benefits, RCFs, which had been losing appeal since 2008 and hit rock bottom in 2012, have shown rapid growth since last year.

In 2008, when the global financial market crashed during the meltdown that started with the Lehman Brothers’ bankruptcy, investors in RCFs suffered major losses when knock-ins occurred.

In 2012, there were 10 RCFs amounting to a total investment of 78.3 billion won.

At the end of last year, there were 12 funds with a total of 114.4 billion being managed.

With the rising popularity, Mirae Asset last week launched an RCF fund promising 12 percent profit unless the indices fall more than 30 percent.

“Although the RCF was introduced in the market in 2008, investors shied away that same year after the global crisis occurred,” said Lee of Mirae Asset. “But after hitting bottom in 2012, investors have been showing signs of interest since last year.”

BY JUNG SUNG-EON AND LEE HO-JEONG [ojlee82@joongang.co.kr]