Active or passive? The ‘father of Korean ETFs’ makes his case

As the ETF market expands at a rapid clip, investors are finding it harder than ever to decide which funds to buy. With more than 1,000 products to choose from, the first major decision most face is whether to go active or passive.

As of Tuesday, 1,163 ETFs were listed on domestic exchanges, according to Korea Exchange, with combined net assets of 439.08 trillion won ($310 billion). The number of companies issuing ETFs has reached 28.

That marks a 47.77 percent increase from 297.14 trillion won at the end of last year, a period during which the number of listed ETFs grew by 105. The expansion looks even more striking against the end of 2021, roughly five years ago, when total ETF net assets stood at just 73.97 trillion won and only 533 products were listed.

ETFs can be bought and sold through a standard brokerage account just like individual stocks, and their portfolio holdings are disclosed transparently. They are also valued for offering diversification with a minimal initial outlay and for carrying lower management fees than conventional funds.

So which ETF should investors buy? Broadly, ETFs are divided by management style into active and passive. Of the funds currently listed, 841 — about 72.3 percent — are passive, while 322, or 27.7 percent, are active.

At the end of 2021, passive ETFs numbered 491 and accounted for 92.12 percent of the total, while active funds made up less than 10 percent with just 42 products. Passive remains the dominant force, but active has grown sharply over the past five years.

What sets the two apart?

Passive ETFs, now the market standard, aim for steady long-term growth. They replicate benchmarks such as the KOSPI 200, S&P 500 and Nasdaq 100, or invest in broad thematic baskets of blue-chip stocks, bonds, real estate and other relatively resilient assets.

Frequent trading is not required, and the value of the investment tracks the market’s ups and downs. Because fund managers have little discretionary latitude, management fees are relatively low, and the broad asset exposure inherent in tracking an index provides strong diversification.

Active ETFs, by contrast, start from the premise that markets are inefficient. Rather than simply replicating a benchmark, they target returns that exceed it. The benchmark serves as a reference point, and fund managers select holdings and time trades in pursuit of outperformance.

Active funds can more precisely match individual investors’ goals and interests, and are generally regarded as better suited to falling markets or periods of high volatility. Active managers can respond nimbly to swings and adjust positions to limit the damage.

That said, active managers do not have unlimited freedom. Under KOSPI listing rules, active ETFs must maintain a daily return correlation coefficient of at least 0.7 with their benchmark index. The threshold for passive ETFs is 0.9.

A coefficient closer to 1 means the fund moves in near-lockstep with the index. Active ETFs are structured to move broadly in the same direction as their benchmark while seeking excess returns within a defined range. If a fund holds different securities or weightings from the index, the coefficient can fall below 0.7.

An ETF becomes subject to delisting if it fails to meet the correlation threshold for three consecutive months, or if its net assets fall below 5 billion won. The coefficient is calculated using the daily return fluctuations of the ETF’s net asset value and its benchmark over the preceding year, meaning past performance is continuously factored in. ETFs listed for less than a year are exempt from the requirement.

This structure has drawn persistent criticism that many active ETFs are “active in name only.” Financial regulators are working on reforms to the correlation coefficient rules, but the timeline remains unclear. Industry players have called for lowering the current threshold or easing the conditions under which a prolonged breach triggers delisting.

The number of disclosure filings for correlation coefficient breaches reached 561 through Wednesday, 8.7 times the 64 filings recorded for all of last year. The number of products that triggered such disclosures rose from two last year to 18 this year, and the number of asset managers involved climbed from two to nine.

There have been actual delistings. Last month, four products managed by Korea Investment Management — “ACE TDF2030 Active Qualified,” “ACE TDF2050 Active Qualified,” “ACE Apple Value Chain Active” and “ACE TDF Long-term Asset Allocation Active” — were delisted after their returns so far exceeded the benchmark that the correlation coefficient dropped below 0.7.

While ETFs have previously been delisted for falling below the 5 billion won net asset threshold, this marked the first time products were removed for outperforming their benchmark, drawing wide attention across the industry. Timefolio Asset Management’s “TIME Global Top Pick Active” faced the same risk but survived because the one-year exemption applied to newly listed ETFs. The episode has amplified calls for a regulatory environment that gives active ETF managers more operational flexibility.

How have listed ETFs actually fared this year? Leveraged ETFs — which target twice the return of their benchmark index — dominated the top of the performance rankings.

Excluding leveraged products, the best-performing ETF was “HANARO Fn K-Semiconductor,” which surged 137.18 percent as of Tuesday compared with its closing price at the end of last year. The fund allocates more than 87 percent of its portfolio to Samsung Electronics, SK Hynix, SK Square and Samsung Electro-Mechanics, all of which posted sharp gains.

Close behind were “RISE Network Infrastructure” (134.75 percent), “IBK K-AI Semiconductor Core Tech” (120.24 percent), “KODEX 200IT TR” (119.53 percent), “PLUS Global HBM Semiconductor” (115.24 percent) and “TIGER 200 IT” (114.36 percent). All of these funds carry overwhelming weightings in Samsung Electronics and SK Hynix.

With passive products dominating the top rankings, the highest-placed active fund was “WON Semiconductor Value Chain Active” at 109.71 percent, coming in 10th overall. “KODEX Asia AI Semiconductor ex-China Active” (99.97 percent), “UNICORN SK Hynix Value Chain Active” (99.42 percent) and “ACE Life Asset Shareholder Value Active” (98.39 percent) also posted strong results. These products, too, carry heavy concentrations in Samsung Electronics and SK Hynix.

Bae Jae-gyu, chief executive of Korea Investment Management, is widely known as the “father of Korean ETFs” for introducing the product to South Korea in the early 2000s and playing a leading role in developing the market. He has long championed the merits of passive ETFs as a vehicle for long-term investment in future growth.

In a book published last November titled “Anyone Can Get Rich Through Investing,” Bae devoted a chapter to what he called the paradigm shift toward passive management.

“In the United States, the introduction of Regulation Fair Disclosure in 2000 eliminated information asymmetry and effectively erased the edge that active managers once held,” he wrote. “Active funds increasingly failed to match market returns despite charging high fees. Passive strategies, meanwhile, attracted capital by delivering stable performance at low cost, and BlackRock and Vanguard rode that wave, aggressively expanding their passive businesses to become industry leaders.”

Bae also analyzed how South Korea followed a similar path, noting that fair disclosure rules were tightened following Hanmi Pharm’s delayed disclosure scandal in 2016 and a CJ ENM earnings leak in 2013, making it harder to exploit non-public information and leading to a clear deterioration in active managers’ performance.

He argued that through this process, the competitive focus of asset managers shifted rapidly from “management” to “product and marketing” — that the core competency became not the skill of an individual manager, but the ability to develop products that efficiently capture the performance of a given market and deliver them effectively to customers.

Bae warned, however, that intensifying competition has made product replication commonplace in the ETF market, and that the race to the bottom on fees to gain market share could ultimately hollow out the entire ETF industry over the long term.

Korea Investment Management is currently pursuing a plan to separate its passive and active divisions. The move is expected to maximize the expertise of each unit by giving the passive operation — long the firm’s core business — its own dedicated structure.

Smaller asset managers, by contrast, are pushing aggressively into the active ETF space. With large firms leveraging strong brand recognition and low fees to dominate the passive market, the strategy for smaller players is to target niches rather than compete head-on.

The Kosdaq market, where performance varies widely across individual stocks, and fast-moving thematic areas such as AI and biotech are seen as particularly well-suited to differentiation through a fund manager’s quick reflexes and stock-picking ability.

VI Asset Management launched “FOCUS Financial Semiconductor Holding Bond Mixed 50 Active” on Tuesday. NH-Amundi Asset Management listed “HANARO US S&P500 Active” on Thursday last week. Last month, Midas Asset Management unveiled “MIDAS Bio Healthcare Active,” while DS Asset Management — known for its strength in private equity fund management — released “DS Kosdaq Active” as its first-ever ETF.

Ultimately, active versus passive is less a question of which is superior and more a matter of personal choice. But this year’s performance data carries a somewhat different message. Among the top-performing products, whether active or passive, the deciding factor was how much exposure a fund had to Samsung Electronics and SK Hynix. In a market driven by concentration in a specific theme, what you invested in mattered more than how you managed it.

Adding to the complexity, the correlation coefficient regulation has created a paradox in which active ETFs that generate excess returns can actually be forced out of the market. For investors, that makes it more important than ever to look beyond management style and scrutinize a fund’s holdings, benchmark, fees and net asset size — while also being clear about their own investment direction and time horizon.

jiyun@heraldcorp.com