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South Korea ETF Investing 101 (EWY, FKO)

July 24th, 2012

Eric Dutram: The latter half of fiscal 2011 was a difficult time for developed as well as emerging markets. Socio-economic as well as political issues caught the limelight worldwide. Concerns over the euro zone continue to plague investors and the effects are not only limited to the European and American markets but were also felt in Asian markets as well (see Euro Small Cap ETFs: The Way to Play Europe?).

Many Asian stock markets have been showing signs of a recovery since the start of fiscal 2012. However, with the worsening situation in Euro zone and consecutively weak unemployment numbers from the U.S., Asian markets have again begun to witness a bearish reversal (read ETF Trading Report: China, Global ETFs in Focus).

In fact, the Chinese economy is growing in at a below average pace due to slowdown in the manufacturing sector while things aren’t much better in the rest of the BRIC bloc. India grew just by a mere 5.3% for the January-March quarter, well below expectations.

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This is a very low figure compared to the impressive show put up by the Indian economy in the recent past, further signaling the BRIC weakness (read Indian Rupee ETFs: Is The Slide Over?).

Beyond these two major markets, some are also growing more concerned about a quasi-emerging market in the region which could face a slump as well. South Korea is perhaps one of the best ‘emerging’ markets for many investors although it often suffers from high levels of volatility thanks to its relatively liquid market and intense political issues.

South Korea: Economy and Politics

Thanks to a hostile neighbor on its Northern border, South Korean markets are often dictated by political problems. This can be somewhat surprising as the country is generally one of the most stable in the world but is obviously right next door to one of the most volatile regimes on Earth.

Generally speaking, this saber rattling with the North has a very negative impact on South Korea’s stocks and confidence by foreign investors. As a result, foreign fund flows (portfolio flows as well as direct investments) are also impacted in a big way and can thus see big swings in a short period of time.

Beyond this, investors should note that the South Korean economy is Asia’s fourth largest economy and is heavily dependent on exports. The U.S and European markets form a major part of the revenues for Korean exporters.

However, with shrinking demand for goods and services from western economies, revenues for exporters have also started to shrink. As a result, the Korean economy has not been able to grow at the pace that it normally does (read Are Korean ETFs in Trouble?).

Rising inflationary pressure and low policy rates by the Central bank, Bank of Korea, have also led to the South Korean won underperforming versus the United States Dollar (USD). In this regard, it is prudent to note that many emerging as well as developed market currencies have lost substantially versus the USD on account of extremely low interest rates scenario in the U.S economy and global risk aversion.

While this trend can certainly help the exporters in the nation, it can result in stock price weakness for investors from outside Korea as well, especially if the strong dollar trend continues (read Dollar and Yen ETFs to Benefit from the Greek Drama).

South Korea: YTD Stock Market performance

The Asian markets got off to an impressive start since the start of 2012 on account of strong international and domestic cues. The announcement of the Greek bailout package of €130 billion by the European Union earlier in March and favorable economic data from the U.S. were some of the developments driving the positive market sentiments. (Read How to Play the Spain ETF (And the Euro Zone Slump))

Most emerging, as well as developed nations’ stock markets rebounded and South Korea’s GDP growth accelerated in the first quarter of fiscal 2012. During this time the benchmark South Korean stock market, KOSPI, gained almost 10.27% (absolute returns) from January till March. Thereafter, since the beginning of April till date, the index has slumped by almost 11.21%.

Due to this, we see that the broad market slump after March 2012 has pretty much wiped out gains from the first quarter. However, this also means that presently the markets are trading at an attractive valuation at current levels, indicating good entry points. Presently the markets look oversold and there could be subsequent and sharp market rallies.

However, questions have to be raised about a broader market recovery as the future of the Euro zone and its constituents remain in doubt. As investors gear up for developments to be triggered in the Euro zone, it is expected that South Korean markets will show signs of resiliency with policy and reform planning in order to stimulate growth and stability in the economy.

For investors looking to play this trend in basket form, either of the two South Korean ETFs highlighted below might be excellent choices, assuming of course that the markets can rebound and risk tolerance for Asian markets is relatively high:

iShares MSCI South Korea Index (NYSEARCA:EWY)

EWY tracks the MSCI Korea Index which measures the performance of the broader South Korean equity markets. The index is a float adjusted, market capitalization weighted index which mostly consists of publicly traded large cap stocks. The ETF was launched back in mid 2000 and has total assets of $2.53 billion.

It is also one of the most liquid and actively traded ETFs in this space as indicated by its average daily volume of 2,390,678 shares. The ETF also adds a U.S flavor in its portfolio by holding depository receipts issued by Korean companies that are traded in the U.S equity markets.

EWY presently holds 106 securities with a 51.11% allocation towards its top 10 holdings. However, the performance of this ETF is heavily dependent on Samsung Electronics Co. Ltd. as more than 22% of EWY’s total assets are allocated towards it. A substantial allocation is also given to fellow heavyweights like Hyundai Motors and Posco which have a combined weighting of more than 10%.

It is prudent to note that a majority of its total assets are invested in export dominated large cap companies. These have, however, taken a beating in terms of revenue due to diminishing export demand on account of the global economic uncertainties (ReadThree Defensive ETFs for a Bear Market).

The ETF is heavily exposed to sectors such as Technology, Consumer Discretionary, Industrials and Financials. EWY has had a pretty volatile last one year. Like most of the Asian emerging markets ETFs, EWY has exhibited a dismal performance, slumping -19.57% in the last one year period. A 52 week low of $44.67 and high of $68.03 for EWY gives us an idea about its volatility.

First Trust South Korea AlphaDEX (NYSEARCA:FKO)

Launched in April of 2011, this is the latest addition in the South Korean ETF space. FKO is designed to track the Defined South Korea Index which is a subset of the S&P South Korea BMI Index.

The ETF employs AlphaDEX methodology, selecting stocks which have the potential to generate a positive alpha relative to traditional passive indexing approach.

Stocks are ranked based on various fundamental as well as growth factors. Based on these ranks, the stocks are assigned weights with higher ranked stocks receiving more weights. Thanks to this unique methodology, the ETF charges 80 basis points in fees and expenses which is much higher than its other South Korean counterparts.

The ETF is comprised of 50 stocks from the entire spectrum of market capitalizations, although it does have a large cap bias. Also, it does well in allocating 32.30% in its top 10 holdings.

It has been over a year now since the ETF has debuted, however, investors are still reluctant to show confidence in this product. Total assets of $1.05 million and an average daily volume of 2,589 shares bear testimony to its unpopularity. Moreover, a high expense ratio adds to investors’ woes. In terms of sector composition, Industrials (27.96%), Consumer Discretionary (15.16%) and Financials (14.56%) form a majority of its portfolio. (see Play A Consumer Recovery With These Discretionary ETFs)

The ETF has slumped -29.12% in the previous one year period. This is mainly attributable to the slump in the emerging Asian markets on account of global woes.

However, the ETF had shown signs of recovery since the start of 2012, returning 9.89% for the first quarter, but since then it has again showed signs of a downtrend fetching -16.41% from April till the beginning of June given the worsening situation in the Euro zone.

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Written By Eric Dutram From Zacks Investment Research

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.


NYSE:EWY, NYSE:FKO


 

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