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South Korean ETFs: Best Way to Play Asia?

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Economic uncertainty all over the world has taken its toll not only on the developed equity markets, but has also cast its shadow over some of the emerging markets as well. Euro zone woes and the unemployment level in U.S. continue to shake investor confidence while worries over Chinese growth are also becoming a concern (Three China ETFs Still Going Strong).

With this backdrop, we would like to highlight Asia’s fourth largest economy, South Korea. In the recent global economic turmoil, the South Korean economy was somewhat less affected by the uncertainty and is usually regarded as one of the more stable economies in the region, despite its emerging market status (South Korea ETF Investing 101)

According to the Korean brokerage houses, the South Korean economy is expected to grow at the rate of 3.2% in 2013. The country still has plenty of room to grow too, as gross national income per capita was $20,870 last year, compared with Japan’s $45,180 and Hong Kong’s $35,160, according to World Bank data.

The resilience of this economy even in times of global financial turmoil may be attributed to the strength of three world beating Korean companies, namely, Samsung, Hyundai Motor Co. and its affiliate Kia Motors Corp. While Samsung phones account for nearly a quarter of the world’s mobile phones, Hyundai and Kia are amongst the top six most profitable automobile markers (Forget the BRIC ETFs, Focus on the PICKs).

Clearly, export plays a key role in South Korea’s economic structure as half of the economic output is dependent on it. South Korea exports a major part of its goods to European and U.S. markets. So, the protracted economic weakness in these two regions has hurt exports from South Korea due to deflating demand (Are Korean ETFs in Trouble?).

The country is nevertheless pursuing certain measures so as to provide a boost to domestic demand in order to set off the slowdown of exports to U.S. and European markets.

Also, in an attempt to stimulate growth of the sputtering economy, the central bank has been continuously decreasing its interest rate. The Bank of Korea has cut rates twice in a span of four months. In the most recent announcement, the central bank has cut the rate to 2.75% from 3%.

Faltering exports and domestic slowdown may somewhat limit South Korea’s economic growth rates. Still, this region remains an interesting choice for investors when compared to other developed regions.

This is especially true when investors compare it to other developed markets which are not seeing such high growth rates, nor do they have the technological and manufacturing prowess of the nation.

Given this, Korean ETFs could be an interesting way to target the market heading into 2013. For investors seeking to delve into this slice of the market in basket form the following options are available:

iShares MSCI South Korea Index (EWY)

Launched in May 2000, EWY is linked to the MSCI Korea Index. The Index has been designed to measure 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 fund is rich in both volume and asset base. It trades with an asset base of $2.9 billion and is considered to be one of the most liquid options available in the space trading with a volume level of more than 2 million shares a day (Guide to Most Popular ETFs).

EWY provides exposure to 107 South Korean securities which mostly covers the large cap section of the market spectrum. The fund appears to be quite concentrated in its top 10 holdings as nearly 50% of the asset base goes towards it. One of the top mobile makers of the world, Samsung plays a very dominant role in the fund with 22.3% of the asset base allocated to it.

So the fund’s impressive performance last year is largely driven by Samsung. This is closely followed by other large companies of the South Korean economy which play a very influential role in its growth. Hyundai takes a share of 5.6% in the fund while Posco is allocated 3.7% of the asset base. Kia takes the fifth position in the fund with an asset allocation of 2.8%.

Among sectors, the fund appears to be highly invested in information & technology. The fund allocates 32.9% of the asset base to the sector. Other than this, the fund assigns double-digit allocation to consumer discretionary, financials, industrials and materials. Among others, the fund does not invest more than 5.82%.

The fund’s performance in 2011 has been disappointing delivering a negative return of 11.73%. This is mostly attributed to weak demand for Korean goods from U.S. and Europe which led to export shrinkage. However, in the last one year, the fund has done a good job setting off all the losses of 2011 and delivering a return of 21.9% (Inside the Two ETFs up More Than 140% YTD).

The fund charges a fee of 59 basis points annually from investors and has generated a yield of 0.62% in the process.

First Trust South Korea AlphaDEX (FKO)

Launched in April 2011, First Trust South Korea AlphaDEX (FKO - Free Report) is the latest addition to the family of South Korean ETFs.

FKO is a passively managed ETF designed to track the performance of the Defined South Korea Index, an index dominated by the stocks selected on the basis of the AlphaDEX screening methodology.

The AlphaDEX methodology for selecting stocks uses both growth and value factors for determination of the stocks to be included in the fund. In this way, investors get a blend of both growth and value stocks in one fund.

Unlike its iShares counterpart, the fund is not popular among investors as indicated by the trading volume of just 1,300 shares (Guide to the 25 Most Liquid ETFs). Also, since its inception, the fund has been able to amass an asset base of $1.3 million, much lower than EWY. So it appears that EWY dominates investor portfolios when it comes South Korean ETF investing.

The ETF also provides exposure to a very small basket of just 50 stocks. This fund is also inclined towards large caps which cover 73% of the holding pattern. Among other market spectrum, the fund has mid caps in its holding and no allocation has been made to small caps.

The fund appears to be moderately concentrated in the top 10 holdings in which it allocates 36% of the asset base. Interestingly in this fund, Samsung does not appear to dominate the holding pattern as it has been allocated the 28th position with just 2.01% of the asset base.

In terms of sector allocation, industrials dominate the holding pattern with double-digit allocation of 25.9% (Three Industrial ETFs Outperforming XLI). Consumer discretionary, consumer staples, financials and materials also get double-digit allocation in the fund. In the top 10 holdings, 4 companies are of the industrial sector.

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