Following the Bank of Korea’s two consecutive base rate hikes, money has continued to flow out of South Korean bond funds, while ultra-short-term bond funds—relatively insensitive to interest rate fluctuations—have attracted concentrated inflows. With upside pressure on market rates persisting due to the possibility of additional tightening, investors are clearly moving to shorten duration in bond investments to reduce interest rate risk.
According to financial data provider FnGuide on the 2nd, total assets under management in South Korean bond funds stood at ₩88.6344 trillion (approximately $64.8 billion) as of the previous day, down ₩385.1 billion (approximately $281.7 million) over the past month. Outflows from bond funds have persisted throughout the year as expectations for base rate cuts have receded and market rates have climbed. In the first half of the year, the relative attractiveness of risk assets such as equities—boosted by a strong domestic stock market—also weighed on bond fund performance.
Breaking down by fund type, the divergence in fund flows was stark. Government and public bond funds, which primarily hold bonds issued by government and public sector entities, saw assets shrink by ₩625.5 billion (approximately $457.6 million) over the past month. In contrast, ultra-short-term bond funds, which invest mainly in short-maturity bonds, attracted ₩648 billion (approximately $474.1 million) in inflows.
The performance gap becomes even clearer when comparing returns over longer horizons. Over the past three months, government and public bond funds posted a loss of -1.69%, while ultra-short-term bond funds delivered a positive return of 0.80%. On a six-month basis, government and public bond funds fell 4.63%, while ultra-short-term bond funds rose 1.50%, demonstrating their defensive qualities.
The key driver behind the divergent performance of bond funds is the rise in market interest rates. The Bank of Korea raised the base rate by 25 basis points from 2.50% to 2.75% in July, followed by another hike to 3.00% last month. Bond prices typically move inversely to interest rates, and the longer the maturity, the greater the price volatility in response to rate changes. During rate-hiking cycles, long-term bonds face heightened mark-to-market loss risk, whereas ultra-short-term bonds have low price sensitivity and mature quickly, making it relatively easier to reinvest proceeds into higher-yielding bonds.
The view that the Bank of Korea’s tightening cycle is not yet over—despite two consecutive hikes—is reinforcing this shift toward shorter duration. The Bank of Korea’s own six-month rate projections show additional hikes remain the dominant scenario. Of the 21 projection points submitted by seven Monetary Policy Board members last month, 10 pointed to a base rate of 3.25% six months ahead, while 6 pointed to 3.50%. Only 5 projection points were placed at the current level of 3.00%.
Hana Securities projects that the Bank of Korea will hold rates steady next month before hiking again in November and February of next year, bringing the terminal rate to 3.50%. For Korean Treasury bonds, the firm noted that this tightening path has not been fully priced into the market, and that 3-year and 10-year yields could surge to 4.3% and 4.7% respectively at their peaks within the year. Kim Sang-man, an analyst at Hana Securities, said, “As the semiconductor export cycle gradually spreads across the broader economy, core inflation pressures are also rising,” and maintained his recommendation to reduce duration.
Government bond supply-demand dynamics are also cited as a variable. If net issuance of Korean Treasury bonds next year remains around ₩100 trillion (approximately $73.2 billion), similar to this year, supply pressure could act as an additional headwind pushing rates higher. Ahn Ye-ha, an analyst at Kiwoom Securities, noted, “Despite expectations for new foreign inflows following this year’s inclusion in the World Government Bond Index (WGBI), supply pressure has increased due to demand contraction driven by market conditions.” She added, “If concerns about expansionary fiscal policy persist, the term premium on South Korean rates will likely remain elevated.”
Meanwhile, rate hikes are also affecting margin trading in the stock market. According to the Korea Financial Investment Association, margin loan balances stood at ₩33.337971 trillion (approximately $24.4 billion) as of the 28th of last month, up ₩8.957 billion (approximately $6.6 million) from the previous trading day, extending a nine-consecutive-trading-day streak of increases. By market, KOSPI margin balances fell by ₩92.751 billion (approximately $67.9 million), while KOSDAQ balances surged by ₩101.708 billion (approximately $74.4 million), driving the overall increase.
When the base rate rises, market interest rates typically follow. As securities firms’ funding costs increase, the margin loan rates they charge investors are expected to rise as well. In fact, a survey of margin loan rates at 28 South Korean securities firms showed that the average final rate for 61–90 day loans stood at 8.94% per annum. The average rate for 16–30 day loans was 8.14% per annum.
Concerns are mounting that the combination of high stock market volatility and rising borrowing costs could amplify loss risks for retail investors. If stock prices plunge and investors fail to meet collateral requirements, forced liquidation may follow. In such cases, investors could face both investment losses and interest burdens simultaneously. Experts agree that excessive use of margin loans should be avoided during periods of heightened volatility.
Choi Seok-won, former head of SK Securities’ future business division, identified a solid loan structure as the first principle investors should review during rate-hiking cycles. He advised individuals holding variable-rate loans to calculate how much their interest burden will increase relative to income, and if the burden is significant, to reduce spending or sell assets to bring debt levels under control. He added that the scale of short-term borrowing for stock investment, such as margin loans, should also be aggressively reduced.
For bond investing, he emphasized a phased, dollar-cost-averaging approach and selecting bonds that can be held to maturity based on one’s financial situation. This is because interest rates, like stock prices, are price variables that are difficult to forecast accurately. Long-term bonds, in particular, which pay interest far into the future, can incur short-term mark-to-market losses when rates rise. Holding low-credit-risk bonds to maturity allows investors to recover all scheduled interest and principal, but selling before maturity could result in losses.
However, he cautioned that concentrating all funds in bonds during a rate-hiking cycle is not advisable. During the 2017–2018 and post-2021 hiking phases, rate increases coincided with stock market corrections. But during the 2005–2007 boom period and the post-financial crisis recovery, stock indices rose even as the base rate increased. In the current environment—where financial conditions are being adjusted preemptively in consideration of growth, inflation, and financial stability—the burden on the stock market could be partially offset by improving corporate earnings.
He also stressed that during rate-hiking cycles, investors should be more rigorous in selecting industries and companies with near-term earnings visibility. Industries and companies with long investment horizons and earnings that materialize far in the future face the impact of rate hikes from two angles: rising short-term funding costs and higher discount rates applied to future earnings.