Korea Capital Market Institute

Recently, many mutual fund investors in Korea have complained about expensive distribution fees, and that advisory services provided by fund distributors such as banks and securities companies are not satisfactory despite expensive fees. Under the circumstances, the Korean government decided to cap the annual distribution fee at 1%. In the short run, the price regulation will help curb the mutual funds’ distribution fees. However, the effect cannot last longer. A more fundamental solution to lower distribution fees is to establish an effective competitive structure in the asset management market. In this paper, we analyze the competitive structures in the Korean asset management market, starting by asking the following questions. First, does the Korean asset management market show signals that are commonly detected in a competitive market? Second, does market discipline by investors exist in the fund distribution market? Do the fund products with high distribution fees show more sluggish cash inflows than other funds? Last, if market discipline does not exist in the fund distribution market, why? To answer the first question, we analyze the structure of the Korean asset management market. According to the results, the market is sending mixed signals in terms of the level of competition. Although the entry barriers for new asset management companies are not high and switching funds is not difficult in the Korean market, the asset management industry is still not fully competitive according to some observations such as: Actual entry and exit barriers still remain high in practice; the lack of diversity in distribution channels; high market concentration on just few asset management companies; and no sign of price competition. Regarding the second question, we adopt the OLS regression and try to analyze the determinants of cash inflows to domestic equity mutual funds. The results show that fund returns play a major market discipline role in the market, whereas other price factors such as TER(total expense ratio), distribution fees, and management fees are barely effective in this regard. In other words, there is no statistically significant difference between cash inflows to the funds that charge high distribution fees and funds with low distribution fees. To identify the reason why price discipline does not exist in the Korean asset management market, we test two hypotheses: Investor welfare improvements, and the lack of information on mutual funds. The first hypothesis assumes that funds with higher distribution fees will give more benefits to investors. If the funds with higher distribution fees provide higher returns and if finding these funds requires costly search efforts, buying these funds would be regarded as rational behavior. In the second hypothesis, we assume that mutual fund investors may not be well informed on all of their mutual fund investment options. Generally, investors in the Korean asset management market choose a fund product based on recommendations from financial advisors working at banks or securities firms. Therefore, chances are high that investors do not compare distribution fees of thousands of different products. According to our analysis, the second hypothesis regarding the lack of information better explains the lack of price discipline in the Korean market, whereas the distribution fees of equity mutual funds show no significant correlation with fund returns and search efforts. From the analyses in this paper, we conclude that Korea still needs to focus on building an efficient competition structure in the asset management market. To achieve that, we offer three recommendations. First, any company that applies to enter the asset management market should be approved as long as it meets the requirements stated in the law. Second, the Korean asset management market needs more diversified distribution channels. This has been widely discussed for years, and is essential for both enlarging asset management companies and enabling domestic and foreign independent asset management companies to stand on their own. Lastly and most importantly, policy makers should find ways to effectively provide in formation about the countless number of funds being sold in the market in order to bring about effective market discipline.