Tax rules may hinder ETF growth in Korea, says Samsung AM

Having recently launched the first inverse and leveraged exchange-traded funds in Korea, Samsung Asset Management worries that tax treatment will hinder ETF market growth in the country.

From July, foreign and alternative product-based ETFs will face disadvantageous tax treatment compared to ETFs with Korean underlyings, says Bae Jae-Kyu, chief investment officer of Samsung AM's ETF management division.

ETFs are treated as regular funds in Korea and, as such, foreign-asset ETFs are subject to local taxes (15.4%) for capital gains on each transaction. Investors will have to pay tax on capital gains even if their total gains on ETFs are negative for a fixed period. Due to the structure of these funds, that will substantially reduce their returns.

Foreign-asset ETFs, such as Samsung AM's Kodex China H, will play a critical role in the development of Korea's ETF market, says Bae, but this kind of tax treatment will hinder market growth potential. "Although the current market size of foreign ETFs is about $220 million," he says, "they have strong potential to grow, just like many offshore-domiciled funds."

Meanwhile, Samsung AM is testing the market with new, more complex types of ETFs, which demonstrate Samsung AM's ability for developing new ETF products, says Bae. It listed the Kodex Leverage ETF in February and Kodex Inverse ETF last September. These are the first ETFs of their type launched in Asia, and they have had "meaningful success" in terms of market share of AUM, he adds.

In particular, Kodex Leverage has the largest trading volume in terms of the number of shares traded, and inverse ETFs are in the top three in terms of trading volumes in Korea. These results may indicate the speculative tendencies of local investors, says Bae.

ETF providers such as iShares and State Street, and regulators such as the US Securities and Exchange Commission, have expressed concerns over more sophisticated ETF products such as these, including whether they are completely suitable for investors.

Samsung AM aims to have W3 trillion ($2.7 billion) in ETF AUM by the end of this year and expects to continue to hold the largest market share in this area.

As of April 16, Samsung AM had 45.18% market share, followed by Woori AM (21.6%), Mirae Asset (13.36%) and KB AM (7.89%) -- there are 12 firms in the domestic ETF market. Samsung AM's market share of equity ETFs is around 57.4%.

The firm's first ETF to launch was Kodex 200, launched in 2002 and whose total asset value stands at around $1.3 billion, making it the firm's biggest by AUM. Other significant ETFs in terms of asset size include Samsung AM's Kodex Samsung Group Equity, Woori Kosef200 equity, Woori Kosef Treasury Bond and KB AM's KStar Treasury Bond. Samsung AM manages 16 ETFs, followed by Mirae Asset with 14 and Woori AM with 10.

As of the end of March, Korea's ETF market ranked 11th globally by AUM, behind Japan, Hong Kong and China in Asia, according to kodex.com. By traded volume, Korea Exchange (KRX) ranks 14th among exchanges worldwide.

Korea's ETF market first opened on 2002 and since then its net asset value (NAV) has grown more than tenfold -- the first year's NAV was around $300 million and the figure is now around $4.3 billion. The number of onshore ETFs has risen from four in 2002 to 55 as of the first quarter of 2010.

Korean equity ETFs account for 73.5% of the market by AUM, followed by domestic bond ETF products at 22.14%. The remaining 4% or so are international equity and commodity-based ETFs offered by local managers.

Under the Financial Investment Services and Capital Markets Act, which became effective in February 2009 (and is also known as the Capital Markets Integration Act), Korean ETF products' underlying assets can include fixed-income products, derivatives and commodity futures, says Bae. Before the law came into force, ETFs were confined to domestic equity underlyings.

Bae, regarded as one of the pioneers in the Korean ETF industry, started his career with Korea Merchant Banking Corporation in 1989 and joined Samsung AM in 2000.