The biggest hedge fund manager in South Korea has blocked investors from pulling more than $500m from its funds after a regulatory probe into alleged illegal trading activities, in a move that highlights broader problems with liquidity in the country’s convertible bond market.
Seoul-based Lime Asset Management, which manages assets worth about Won4.9tn ($4.1bn), last week froze as much as Won620bn over two of its funds after it received more requests for redemptions than it was able to meet. The assets affected are mostly privately placed securities such as convertible bonds issued by companies listed on Kosdaq, the country’s tech-heavy bourse, or bonds with a warrant attached.
The country’s financial watchdog said it was looking into the matter and had asked Lime to submit plans on how it would honour investors’ withdrawal requests. The two funds have about 3,000 individual investors, according to local media.
“We’ve seen a flood of redemption requests over the past three months amid a dearth of new investments into the funds,” Won Jong-jun, chief executive of the seven year-old firm, told the Financial Times on Thursday. “Through consultation with regulators and lawyers, we’ve made the decision to minimise investors’ losses as we couldn’t liquidate our assets as fast as investors wanted.”
The increase in investors’ requests for their money back came after South Korea’s Financial Supervisory Service launched an investigation in August over allegations that Lime was manipulating the returns of some of its funds by trading assets between them. The FSS recently completed its probe and will report soon on its findings, said a person close to the investigation.
Lime’s Mr Won declined to comment on the allegations.
South Korea’s top financial regulator, Eun Sung-soo, told reporters on Thursday that his Financial Services Commission, the parent of the FSS, would step up monitoring of the industry to prevent any systemic risks stemming from Lime’s woes.
Korean hedge funds have sharply increased their investments in convertibles issued by small and midsized companies, as they search for higher yields. Convertible bonds grant investors the right to swap interest-paying debt for equity if a company’s shares rise to a pre-determined price.
Investors usually get a lower coupon on convertibles compared with regular bonds, in exchange for the option to own stock down the line. The advantage for issuers is that they raise money more cheaply than straight debt, and without immediately diluting shareholders’ equity.
The issue is expected to throw cold water on the fast-growing domestic hedge fund industry. Concerns over the illiquidity of hedge fund investments have grown recently as some South Korean investors lost most of their principal in a derivative product tied to German government bonds.
South Korean companies have issued almost $3.3bn in convertible bonds since the start of 2014, according to data from Dealogic. In July LG Display, the world’s second-largest manufacturer of flat panels, raised a record $690m with one such bond.
Hwang Se-hoon, a researcher at the Korea Capital Market Institute, said that convertible bonds normally had wide bid-offer spreads because the market was “not deep.” Lower stock prices were also making trading of convertible bonds more difficult, he added. The Kosdaq dropped almost 30 per cent between April and August, significantly lagging the broader Kospi.
“You will suffer big losses because you have to offer bigger discounts if you want to sell them quickly,” he said. Mr Hwang predicted that the difficulties experienced by Lime were unlikely to spread to other hedge funds, but added that the episode was “a warning sign for the industry’s aggressive investments into risky assets”.