With data showing Korean bond market reacting to possible rate hikes during the third quarter trading, it appears that now’s as good a time as any to add positions in Korean fixed income.

Staple Korean bond funds recorded the greatest outflows from July to September, after three consecutive quarters of net inflows. The Korea Bond category alone lost 1.1 trillion won ($925 million) in investments in the third quarter, after a combined 5.7 trillion won of net inflows from the previous two quarters, according to the latest Morningstar data.

 
Top laggards by Morningstar fund categories

Similar outflows in bond funds also occurred in Hong Kong, Singapore, and Taiwan in the same quarter.

“I think there's more of a reallocation than outright outflows that we see from Asian bonds right now,” Neeraj Seth, head of Asian credit at BlackRock, told AsianInvestor during a webinar on Tuesday.

Neeraj Seth, BlackRock

“Given the market has started to price in [the rate hikes], we actually like the Korean bonds here. I don't think you will get as much of the policy hikes in the next 12 months as what the markets are pricing in. But during that repricing, you did see the outflows in that specific market,” Seth added.

Most outflows came from the Korea Corporate Bonds category, which invest in corporate-issued securities in the Korea market.

"Funds in this category are more sensitive to interest rates than government bond funds. And hence this explains the heaviest outflows,” noted Andy Jung Seung-hye, director of manager research with Morningstar Korea.

Funds with the most net outflows are those with short durations, including Eugene Champion Short-term Fdr Bond A, Woori Short-term Bond A, and KIM eShort-term ESG Bond CP.

In contrast, equity funds attracted 5.8 trillion won of new money in the third quarter, compared to a net inflow of 4.1 trillion won overall for Korea-domiciled funds. The top 10 investments with highest net inflows during the period were all exchange-traded funds (ETFs).

Top 5 Korean funds with most net inflows in Q3 (billion won) (Source: Morningstar)

KODEX 200

1279.85

TIGER China Electric Vehicle Solactive

980.12

TIGER Glbl Lithium&Btry Tech Slctv Synth

657.81

TIGER US Tech Top10 INDXX

569.27

TIGER NASDAQ100

390.64

The outflows occurred as traders started to prepare for rate hikes amid rising inflation. On Thursday, as the market had expected, the Bank of Korea raised base rate for the second time since August by 25 basis points to 1%, after the consumer price index (CPI) climbed to a 10-year high of 3.2% in October.

“The Korean market is quite sensitive to that kind of market movement. Because I think Korean institutional investors and also retail investors, they tend to regard fixed income as risk-free assets,” said Jang Dong-hun, chief investment officer of Public Officials Benefit Association (Poba) in Korea.

Jang Dong-hun, Poba

“The reality is that after they go through some market turbulences in the fixed income market, then they realize: wow, it is not risk-free. And they just all run away from it,” Jang told AsianInvestor.

He believes the market has priced in and absorbed BOK’s second rate hike ahead of time.

As Poba’s fixed income investments are mostly in private debt funds, structured notes, and collateralized loan obligations (CLOs) rather than plain vanilla-type fixed income securities, Jang noted that the pension fund is not too sensitive to such short-term valuation turbulences.

Poba has $15.2 billion in assets as of the end-June, with about 10% in fixed income.

Andy Jung, Morningstar 

In the rate increase announcement on Thursday, BOK revised up its inflation outlook to 2.3% for the year and 2% for 2022. It may further adjust its monetary policy by assessing the Covid situation, inflation, the economic outlook, and any financial imbalances.

ESG FUNDS AFFECTED

Bond outflows in the third quarter have resulted in a significant decrease in ESG fund investment in Korea, with 14.2 billion won incoming — compared to 925.9 billion won in the second quarter, and 2.1 trillion won in the first quarter. This was despite the launch of nine sustainable funds during the period, compared to six in the previous quarter.

The slowdown has eroded Korea’s total ESG fund market size to $5.04 billion, with its second-largest ESG fund market status overtaken by Taiwan in Asia excluding Japan region. China is still the largest with $47.6 billion worth of assets as of end-September.

Asia ex-Japan ESG fund market rank by asset size (Source: Morningstar)

AUM (USD)

     2021 Q3

China

     47,634,435,507

Taiwan

       5,119,883,797

South Korea

       5,042,836,476

India

       1,653,989,147

Hong Kong

          940,398,160

The heaviest divestments were seen in the KIM eShort-term ESG Bond fund, Woori HiPls ST Feeder Supr ESG Bond fund, and KIM Credit Focus Feeder ESG Bond fund, which altogether saw 380 billion won in net withdrawals in the third quarter.

But in the long term, ESG investments are still expected to be on the rise.

“In Korea, it is expected that institutional investors would increase ESG investments continuously — especially public pensions and public funds. Public money is partially driven by policy. However, performance is still a key driver in the ESG fund space,” Morningstar Korea’s Jung told AsianInvestor. 

Among new ESG funds launched in Korea in the third quarter, the KB Star ESG Bluechip Mid ST Feeder Bond fund was the most popular, drawing 103.2 billion won of new money from investors.