By Kim Da-ye
“Wrap accounts” or privately managed accounts have been the rising star in Korea’s investment scene in the past year with their multi-trillion won assets doubling in less than a year. But the lack of the right regulatory tools in the fast-heating up market is posing a question if such popularity is sustainable.
Though its meaning varies in different countries, wrap accounts in Korea are comprehensive asset management services in which a brokerage manages an investor’s portfolio tailored to his or her targets and needs.
Wrap accounts largely divide into two types: “discretionary” accounts and “advisory” ones. For the former, a brokerage is “discredited” to manage an investor’s portfolio while the latter involves investment advisors who recommend items to put money into.
The idea of “one investment manager for one investor” has apparently appealed to many Koreans. The total sum invested in wrap accounts has ballooned from 13.3 trillion won in March 2009 to 27.6 trillion won in May 2010, according to the Financial Supervisory Services (FSS). The “advisory” accounts have been particularly in demand for those pursuing high profits with their size growing from 28.4 billion won to 1.36 trillion won during the same period.
There is no official data, but many experts in finance say that money is flowing from mutual funds to wrap accounts. During the recent financial crisis, many investors saw the value of their assets in mutual funds dropping.
With the benchmark Korea Composite Stock Price Index (KOSPI) rising again, many are selling back their equity funds en masse to save at least their principals. Between March 2009 and May 2010, the size of equity funds shrunk by 20.7 trillion won while that of wrap accounts grew by 14.3 trillion won.
A few features of wrap accounts may whet the appetite of investors who have been disappointed with the profitability of mutual funds. Firstly, investors supposedly deal directly with the investment managers and should be able to solicit the compositions of their portfolios to an extent.
Investors can also check how their portfolios are doing in real time on the home trading system (HTS) while the same information for mutual funds will be disclosed every month or even every three months.
Furthermore, those investing in wrap accounts do not pay cancellation or reselling fees while mutual funds charge users until a certain period of time. Brokerages bill wrap account holders a portion of the invested sum as handling fees.
Such fantastic terms for wrap accounts, however, come at a price. Wrap accounts are supposedly for the wealthy who can usually put in more than 100 million won. A large investment makes sense for the brokerages that get part of it.
But the local trend shows that the minimum required investment has lessened as securities companies try to lure more customers and expand their asset management businesses. To the extreme, some experts are worried that wrap accounts have become a marketing tool.
“Brokerages launched ‘installment’ wrap accounts and significantly reduced the minimum required investment, and the difference between wrap accounts and mutual funds is fading out,” Joo Yun-sin and Ahn Sung-hak of Hana Institute of Finance wrote in their report “Domestic wrap account market’s current state and problems.”
“The minimum required investment is as low as 10 to 20 million won and an installment plan can cost just 100,000 won a month. If this phenomenon continues, it won’t be easy for brokerages to tailor asset management services for each investor.”
Joo and Ahn wrote that, for the accounts with relatively little investment, brokerages set the target profit in advance and run the portfolios in similar ways as they manage existing financial products. They did not name any particular products run in that manner.
The biggest risk stemming from such practices is the possibility of brokerages “collectively” managing wrap accounts as they do mutual funds. A Financial Services Commission (FSC) official told the Korea Times that “collective management” is illegal though the FSC hasn’t yet found any illegal acts. He wouldn’t confirm if the FSC is investigating “unfair practices” that could turn out illegal.
For readers’ information, brokerages are allowed to buy instruments in bulk and allocate them differently to each portfolio. “Collective ordering” was legalized in August 2007 after brokerages found it too demanding to buy instruments for each wrap account.
Another concern about wrap accounts is that the composition of the portfolios isn’t regulated, possibly triggering “herd behavior.” The number of items an “advisory” wrap account invests in ranges between eight and 15 while that for an equity fund often exceeds 50.
Equity funds are also limited to investing 10 percent of assets in one item while such a limit does not apply to wrap accounts. Wrap accounts can make an aggressive investment in a few profitable items, but at the same time become vulnerable to changes in the stock prices.
And speculation in a few instruments poses risks to the market as well. When money flows into a small number of stocks, a dramatic increase or drop in their prices can hurt the market. The FSC and FSS said in a recent statement that information about which stocks wrap accounts buy has been revealed by the media and that ordinary investors might follow suit, intensifying the heating up of a few stocks.
Joo and Ahn of Hana Institute of Finance say, “Because wrap accounts now yield high profits, it’s not much of a problem now. But in the future when the stock prices plummet, wrap accounts will receive a huge blow that is worse than what the mutual fund market saw during the financial crisis.”
Kang Ji-young of the Korea Investors Protection Foundation warns of unknown risks of wrap accounts in her contribution to the organization’s publication. “Wrap accounts were introduced in 2001, so the history is very short. There are no relevant precedents, and, because they are tailored to each customer, investment errors are difficult to prove,” wrote Kang.
Both the FSC and FSS pledged in early August that they will come up with a revision to the current investment regulations in September. The FSC official said Thursday that the date of the announcement is unknown and the details of the revision cannot be released yet.
There are a few points that regulators and financial experts agree upon. Many say that each investor should be ensured the rights to actively participate in the asset management of his wrap account. Brokerages’ limiting such rights is illegal in Korea though it is unknown how it is done in reality.
In addition, Lee Ji-eun and Lim Hyung-joon, researchers at the Korea Institute of Finance, wrote in their lengthy report released in August that more information about fees and investment managers should be released to keep the market transparent.
For the most controversial issue on collective management, the financial authorities have mulled raising the minimum required investment, but face opposition from the brokerages that argue such a limit would undermine the growth of the market at its early stage.
“Efforts made by all parties including financial authorities, brokerages and investors are necessary for the sustainable growth of the wrap account market, so that we do not repeat the same mistake we made during the 2007 mutual fund boom,” said Joo and Ahn of Hana Institute of Finance.