Active exchange-traded funds (ETFs) that have delivered returns beating their benchmarks are being delisted after failing to meet the correlation coefficient requirement, prompting calls to improve related regulations. The correlation coefficient is an investor protection tool meant to prevent active ETFs from straying too far from their stated investment universe, but some also say it excessively restricts the management autonomy of active ETFs that pursue excess returns.
According to the financial investment industry on the 19th, Timefolio Asset Management's "TIME U.S. Dividend Dow Jones Active" ETF will be delisted that day. Following the delisting last month of four active ETFs from Korea Investment Management for the same reason, five products will have disappeared from the market in two months for failing to meet the correlation coefficient requirement.
Under Korea Exchange (KRX) rules, active ETFs must maintain a correlation coefficient of at least 0.7 with their benchmarks. If the coefficient remains below 0.7 for three consecutive months, delisting procedures begin.
◇ Correlation falls after generating excess returns… the active ETF dilemma
Once the correlation coefficient drops, it is difficult to recover in a short period even if the manager belatedly adjusts the portfolio. The correlation coefficient is calculated together with cumulative returns over a specific period. Therefore, even if the management strategy is realigned with the benchmark, past figures become a drag, making it hard to lift the correlation coefficient immediately.
A person in the asset management industry said, "Even if you immediately align the portfolio with the benchmark after a large widening in the correlation, it may be hard to recover the standard within three months due to the impact of previously accumulated data," and added, "If you instead cut positions in stocks with strong returns to match the benchmark, you have to give up returns that could be generated through active management, creating a dilemma for managers."
As of mid-May, when it continued active management, the TIME U.S. Dividend Dow Jones Active ETF outperformed its benchmark by more than 9 percentage points over the past year and since listing. But as artificial intelligence (AI)-related stocks surged, its daily return movements diverged from the dividend-focused benchmark, and the correlation coefficient fell.
Timefolio Asset Management explained, "As soon as we confirmed the shortfall in the correlation coefficient requirement, we worked to raise the correlation—such as by reducing the share of positions generating excess returns—but the average daily volatility of the underlying index was very low, leaving too little time for a full recovery."
Some note, however, that delivering higher returns than the benchmark and failing the correlation requirement are separate issues. The correlation coefficient measures how similarly the two products' daily returns move, not whether the ETF outperformed the benchmark. If the portfolio centers on the benchmark's constituents but adjusts only the weights, the correlation can remain high even with large return gaps. Conversely, if the ETF adds many securities not in the benchmark or with a different profile of assets, the product's nature can diverge from what investors initially expected.
For this reason, some say the goal should be to strike a balance between the management autonomy of active ETFs and investor protection, rather than simply scrapping the correlation requirement.
◇ Legal revision needed to introduce fully active ETFs… discussions stuck in place
Because the current Financial Investment Services and Capital Markets Act defines ETFs as collective investment schemes managed in line with changes in an index, a legal revision is needed to allow fully active ETFs that would eliminate the correlation obligation.
As legal revisions take time, the industry is suggesting first fixing the delisting criteria. The idea is to extend the current threshold of three consecutive months below the correlation standard to six months, giving managers time to adjust portfolios and normalize the correlation.
Financial authorities have also set the introduction of fully active ETFs as a policy improvement task. In Jan., the Financial Services Commission announced a plan to introduce single-stock leveraged ETFs and said it would also push for legal revisions to allow active ETFs without index requirements.
The Financial Services Commission (FSC), the Korea Financial Investment Association, and the Korea Exchange (KRX) held a related task force (TF) in Mar.–Apr. to gather industry opinions, but no specific legislative timetable has been presented since. The industry view is that discussions on fully active ETFs are being delayed as resources have recently been focused on follow-up measures related to single-stock leveraged ETFs.
Kim Jae-chil, senior research fellow at the Korea Capital Market Institute, said, "In active equity ETFs, maintaining correlation with the tracking index is not easy, which imposes considerable constraints on setting strategies and changing stock-by-stock weights," and noted, "Given that in most countries active ETFs do not track the direction of a specific index, it would be desirable to abolish the obligation for domestic active ETFs to maintain correlation with the tracking index."
An official at the Financial Services Commission (FSC) said, "We need to continue reviewing the current active ETF correlation coefficient."