Aviation finance funds are expected to attract another billions of dollars from South Korean investors this year to a cumulative $3.9 billion, driven by an increasing number of participants and diversified portfolios. But some early investors turned cautious about the declining return from the crowded market, worrying: South Korea might have caught the last train to the market which has peaked.
Private aircraft funds in the country raised a total of 1.3 trillion won ($1.1 billion) last year, more than quadrupling from 293 billion won in 2012, according to KG Zeroin, a fund rating firm. Including the capital committed to overseas aviation funds, South Korean investors are estimated to have committed a total of 2.5 trillion won ($2.2 billion) to aviation funds.
“Considering strong interest from domestic institutional investors, an additional 2 trillion won ($1.7 billion) could flow (into aircraft funds) this year,” said Byung-soo Yoo, head of KTB Investment & Securities’ alternative investment team.
Mizuho Securities Co. Ltd. and Meritz Securities Co. Ltd. launched a $900 million aviation fund last November, which is the country’s first aircraft portfolio fund consisting of multiple airplanes. Meritz is selling down its equity interest worth 264 billion won in the fund to domestic investors.
Aircraft financing funds are generally expected to deliver an annual return of 5 to 6% for a six- to seven-year investment period. The return would rise to about 10% for subordinated tranches of airplanes funds.
“Unless bond yields go higher than that of aviation funds, there will be almost no other asset classes attractive enough to replace aviation funds now,” Kyung-young Lee, an official of the Police Mutual Aid Association, told a domestic online news outlet last month.
On the flip side, some industry observers say that the recent rally in airline companies, powered by air traffic growth and low oil prices, might be short-lived.
The rise of low cost carriers, increased international flights from the Middle East and a possible rebound in oil prices could trigger a shake-up in the airline industry, as was seen for the US and Japanese airlines in the early 2000s when global travel demand stalled.
With South Korean institutional investors herding to top-rated airlines, the rate of return from aviation funds dropped by 1 to 2% points from two to three years ago, although risks remained lower than other alternative asset classes. High brokering fees also erode the expected return.
“We have studied investing in aircraft funds since late last year. But the cap rate is between 3 and 4%, so our conclusion is that there is no reason to invest there,” a South Korean insurance firm’s CIO told the Korea Economic Daily. The cap rate is the residual value of an airplane divided by net operating profits.
Kyung-soo Chung, chief investment officer of Dongbu Insurance Co. Ltd., said that the insurer had stopped investing in aircraft funds since late last year because competition cut the rate of return. It is the first Korean institution investing in overseas aircraft funds.
To grow the aviation fund market further, Seung-young Lee, a Meritz Securities executive, said that various types of funds need to be introduced, based on multiple aircraft, airplane parts, or a broader range of airlines. He also calls for increasing the size of domestic aircraft funds so that they can gain an upper hand in negotiations.
In February, the Military Mutual Aid Association, South Korea’s military fund, started investing in an airplane leasing fund for Malaysia-based AirAsia, beyond top-tier global carriers. Samsung Securities Co. Ltd. is reportedly seeking to include Qatar Airways in its aviation fund portfolios.
As a brokerage house, Samsung is also keen to underwrite aircraft funds, while a domestic investment firm established an airline leasing firm to save brokering fees for the first time as a Korean firm.
South Korea’s IMM Investment Corp. recently set up an offshore airplane leasing firm. The leasing company with a capital of 100 billion won had purchased seven widebody jets last year and signed a long-term lease contract with Emirates Airlines and Singapore Airlines.
“With the establishment of the leasing firm and a big-size aircraft fund launch, the size and quality of our aircraft fund market has changed dramatically,” said a Korea Investment & Securities. “It signals our aviation financing market is jumping up to take center stage form the periphery.”
KTB Investment and other asset management are known to prepare the launch of public aircraft funds, targeting the high net-worth individuals. South Korea allowed the introduction of public funds of funds from last year.
However, the two-day international airfinance conference held in Seoul late last month, the first such event in the country, added to the voice of caution.
“It seems that aircraft funds failed to drum up interest from the US and Europe, so they came as far as Korea to attract money,” an investment banking source told the Dong-A Ilbo newspaper on Feb. 22.
By Daehun Kim
<Edited by Yeonhee Kim>