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Fee War Rages Among Korean Brokers After Wrap Account Stampede

South Korean investors were crushed by the market crash that swept the world three years ago. The Seoul stock exchange’s Kospi Index (KOSPI) lost 41 percent during 2008, while the most popular mutual fund fell 39 percent.

High-net-worth stock pickers looking for better performance have found Seo Jae Hyeong.

Seo’s Korea Creative Investment advisory firm works with brokerages to sell Koreans “wrap accounts” -- packages of stocks offered as an alternative to mutual funds. Before he founded KCI, Seo was a fund manager at Mirae Asset Global Investments Co., Korea’s dominant mutual-fund company, scoring an average return of more than 35 percent annually over five years.

When he opened KCI in December, money poured in -- 1.7 trillion won ($1.57 billion) within two months of its founding, Bloomberg Markets magazine reports in its May issue.

Seo, 46, is the best known of a growing legion of Korean equity advisers offering personalized investment services. The accounts they advise on are called wrap accounts because all expenses and commissions are wrapped into a single annual fee, which in Korea ranges from 1 percent to 3 percent of a portfolio’s value.

“There should be a purpose to one’s life other than making money for yourself,” Seo says. “I want to help other people get rich by sharing what I’ve learned.” Dressed in a dark navy suit, white shirt and a bright-pink tie, he gestures with his arms as he speaks, revealing prominent scars on his left hand. He got them cutting hay with a sickle on his parents’ farm in southern Korea as a boy.

Photographer: Jean Chung/Bloomberg Markets via Bloomberg

Seo Jae Hyeong, founder and chief executive officer of Korea Creative Investment Co., poses at the company offices in Seoul, Feb. 16, 2011. Close

Seo Jae Hyeong, founder and chief executive officer of Korea Creative Investment Co.,... Read More

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Photographer: Jean Chung/Bloomberg Markets via Bloomberg

Seo Jae Hyeong, founder and chief executive officer of Korea Creative Investment Co., poses at the company offices in Seoul, Feb. 16, 2011.

Wrap Accounts

Seo’s KCI runs what are known as consultant wrap accounts, in which independent advisory firms work directly with brokerage clients, picking stocks and other investments. He has contracts with 20 brokerages, which typically take 80 percent of the fees, while the adviser gets 20 percent.

The number of independent investment advisers and money managers rose to 108 by early 2010 from 52 in December 2005. As of the end of March there were 141, according to the Financial Services Commission, Korea’s regulator. Of the total, more than 20 offer wrap-account advice.

Seo’s startup vaulted to No. 2 in wrap-account assets under management within weeks of its founding. Brain Investment Management Co., started in 2009, is No. 1. Wrap assets at the top 10 brokerage firms rose 44 percent in January alone, to 7.3 trillion won from 5.07 trillion won, according to Samsung Securities Co.

‘Hedge Fund Precursor’

Though Seo invests his clients’ money only in equities, wrap-account holders are free to invest in anything -- including bonds and other securities -- and to concentrate investments to maximize returns.

“It’s that freedom that makes wrap accounts attractive,” says Shaun Cochran, head of Korea research at Hong Kong-based brokerage CLSA Asia Pacific. “They are a precursor to hedge funds.”

The Korean government passed a law in 2009 allowing hedge funds for the first time. The FSC imposed such stiff restrictions on their operation, however, that no local funds had been created as of the end of March. Several global hedge funds, including London-based Winton Capital Management Ltd. and New York-based Millennium Partners LP, have signed contracts with Samsung Securities and other big South Korean brokers that will allow their clients to invest in their funds.

Increasing Wealth

The non-Korean firms are eager to take advantage of the increasing wealth of South Korean society. The number of Koreans with a liquid net worth of 1 billion won or more has almost tripled to 130,000 in the past 10 years, Seo says. High-net- worth Korean families had $340 billion invested in 2009, according to the Asia-Pacific Wealth Report 2010, issued by Capgemini SA and Bank of America’s Merrill Lynch. About 60 percent of it is in real estate and bonds.

Both wealthy and middle-class Korean investors have been drawn to wrap accounts, known as managed accounts in the West, partly by the swoon in mutual funds and a sharp drop in interest rates that make investors’ deposit accounts less lucrative.

So much money has been flowing into wrap accounts that a fee war has broken out. In February, Mirae Asset founder Park Hyeon Joo -- Korea’s biggest mutual-fund manager -- dropped the fee he charges for wrap accounts he sells through his brokerage arm to 1.9 percent from 3 percent. The move was quickly copied by Hyundai Securities Co. (003450) and two other firms.

Fund Boom

The rush into managed accounts is reminiscent of the mutual-fund stampede that preceded it. Korea’s equity fund assets rose more than 16-fold to 140.2 trillion won at the end of 2008 from 8.6 trillion won at the end of 2004. Since the financial crisis broke in late 2008, investors have been fleeing. The funds’ total assets dropped to 101.3 trillion won as of the end of March.

The amount of money in wrap accounts, including consultant accounts, grew to 39.4 trillion won at the end of January from 963 billion won at the end of 2003, according to the latest available figures from the Korea Financial Investment Association. The biggest consultant-wrap-account broker is Samsung Securities, with 3 trillion won in assets under management as of March.

“Korea has a history of herding in its retail investment culture when a theme becomes popular,” Cochran says. “There is a potential for wrap accounts to become another craze and be overdone.”

Outperforming Kospi

Why Seo is an investment celebrity is easy to see from his returns at Mirae. From December 2004 through November 2009, the 11 funds Seo managed -- with assets averaging 5 trillion won -- had an average annualized return of 35.3 percent, outperforming the Kospi’s 15.5 percent, according to KCI.

At KCI, he serves a wealthier clientele. The minimum for most wrap accounts is 100 million won, though in the past year it has dropped as low as 10 million won at some firms. In addition to his brokerage customers, Seo manages money for a coterie of wealthy individuals whose minimum initial investment is 300-million won; they pay fees of as little as 1.3 percent.

Seo’s goal is to lure some of the money Koreans are holding in real estate and bank deposits into his concentrated portfolio of local stocks.

Clients tell KCI portfolio managers their investing goals, and the managers choose from the dozens of stocks that Seo favors. He holds mostly big companies with global businesses, such as Samsung Electronics Co., the world’s biggest television maker; Hyundai Motor Co. (005380), South Korea’s biggest carmaker; and Hyundai Heavy Industries Co., the world’s biggest shipbuilder.

Samsung, Hyundai

Samsung Electronics shares have risen 991 percent since the beginning of 1999 through April 6, while Hyundai Heavy shares have gained 1,866 percent. Samsung Electronics makes up 20 percent of Seo’s portfolio; Hyundai Heavy, 15 percent.

Since KCI started operation on Dec. 13, its model portfolio returned 13.3 percent for the year ended April 6, compared with the Kospi’s 6.5 percent gain, according to KCI. One account it manages for a wealthy client has returned 14.3 percent during the period, the company says.

Song Hong Sun, a research fellow at Korea Capital Market Institute in Seoul, says wrap portfolios can be risky because they include so few stocks. This year, for instance, KCI’s returns have been hurt by the poor performance of Samsung Electronics, which was down 2.7 percent as of April 6, compared with the Kospi’s 3.7 percent gain.

Blue Chips

“What is more risky,” Seo asks, “holding the world’s leading company stocks like Samsung Electronics for a long time or holding a bunch of crappy small caps in the name of diversification of risk?”

On March 8, the day after a big drop in the Samsung Electronics share price, Seo met with 15 of his high-net-worth clients at the Shilla Hotel in Seoul, urging them to ignore short-term volatility and hold on to the stocks of companies with the best profit outlook.

Investors can see the components of their KCI portfolios in real time, and word spreads fast via the media and blogs when Seo is buying or selling. Speculators copy his bets, driving prices higher. It’s a dangerous phenomenon, CLSA’s Cochran says.

“It creates a virtuous cycle on the way up, and it becomes a vicious cycle on the way down,” he says.

The real test of the entire wrap market will come in the next severe downturn, says Mark Mobius, who oversees more than $50 billion as executive chairman of Templeton Asset Management’s Emerging Markets Group.

Downturn Risk

“Investors are now willing to pay higher fees on wrap accounts due to strong performance,” he says. “We will have to wait to see if the same is true during periods of weak performance.”

The Kospi Index soared 66 percent in the two years ended on April 6.

Seo has an academic bent -- a favorite pastime is reading a 15-volume history of the Roman Empire that he acquired from his mother, who home-schooled him in Korean and Chinese history. She died when he was in elementary school.

The farmer’s son paid his way through Seoul’s Yonsei University, where he majored in business administration, by working as a tutor. After finishing school, he worked for 14 years at Kookmin Bank, then moved to Mirae Asset in 2004.

There he became a believer in global warming and invested accordingly. One stock in his portfolio, then and now, is OCI Co., a maker of polysilicon, a material used to make solar panels. OCI shares have risen about 1,390 percent during the past five years, earning the adviser the nickname Solar Seo.

Investing is about more than profit-and-loss statements, Seo says: “It’s about people, industries and the changing environment around us.”

In South Korea, that environment can change rapidly. For the moment, the wind is with Seo and the wrap accounts he has helped make so popular.

To contact the reporters on this story: Yoolim Lee in Singapore at yoolim@bloomberg.net. Saeromi Shin at sshin15@bloomberg.net.

To contact the editor responsible for this story: Michael Serrill at mserrill@bloomberg.net.

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