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Korea ETF: Back on Track After Rate Cut?

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After rate cuts from Europe, India ,and Australia, South Korea apparently had no choice but to get in on the party as well. The Asian nation, much like its aforementioned rate cutting peers, is also looking to boost its slowing economy and spur internal demand.

South Korea, Asia’s fourth largest economy and one of the most stable nations in the world, showed its strong resilience to the global turmoil and turned out to be one of the best performing regions in 2012 (South Korean ETFs: Best Way to Play Asia?).

However, in the new year, when the other economies gained strength, South Korea gave the impression that the economy may be lagging somewhat. The ETF tracking the region had a poor start to 2013.

Why the poor stretch?

South Korea’s housing market is facing a difficult time and could be headed for a bit of trouble thanks to unfavorable demographics. The property market appears to be pinned down by many structural tribulations like an aging population and retiring baby boomers on top of the low-growth environment.

The economy which was already facing troubles from the Euro-zone crisis due to poor exports, has been made more vulnerable by the rising won. This makes exports even more expensive, which is key since exports account for almost 50% of the GDP growth rate of the economy.

Also, with a depreciating yen, supported by economic reforms in Japan, the situation has further aggravated. After all, South Korea often comes into direct competition with Japan, so with the won adding 8% against the dollar and almost 20% against the yen, it was not a good situation for Korea (Are Korean ETFs in Trouble?).

In fact, the government of South Korea has decreased its growth forecast for the economy from 3% to 2.3% for 2013. This comes in the wake of weak exports and a lower domestic consumption.

In this environment of slow growth and a strengthening currency, the central bank of South Korea took the initiative of cutting the benchmark interest rate in order to boost the economy, which is so heavily dependent on exports for growth. This was the first cut made by the bank in a span of seven months, pushing the rate to 2.25% from 2.5%.

ETF Angle

In this sluggish growth environment, ETFs tracking the region are bound to deliver negative returns to an investor. iShares MSCI South Korea Capped ETF (EWY), which offers broad exposure to South Korean equities, ended 2012 with a solid gain of 19.9%.

However, in 2013, the ETF just does not appear to be in good shape as revealed by its year-to-date negative return of 11% (Three Country ETFs Struggling in 2013).

The fund provides exposure to 104 South Korean stocks while investing $3.2 billion in the portfolio. The volume levels are seen at more than one million shares a day while expenses come in at 61 basis points a year.

Samsung plays a dominant role in the fund’s performance as EWY has assigned a healthy 21.6% of its asset base to the company. Samsung continues to gain ground in the smartphone business and is in neck-to-neck competition with Apple's iPhone in terms of sales (South Korea ETF Investing 101).

Despite Samsung’s solid performance in the near term, the ETF does not seem to be in top form. Other top positions have been allocated to Hyundai and Posco with asset allocation of 4.91% and 3.55%, respectively.

The fund is moderately concentrated in the top ten holdings with 48.08% of asset base invested in them. In fact, the fund appears to be quite diversified in terms of sector holdings as well. Among sector allocation, Information Technology, Consumer Discretionary, Financials, Industrials and Materials get double-digit allocation in the fund (Top Ranked South Korea ETF in Focus).

Bottom Line

It remains to be seen if the latest rate cut will be enough to boost Korean stocks in the near term. Prices of EWY have remained sluggish even after the reduction, so it certainly hasn’t had an immediate impact.

However, if the won can fall back a bit from its perch and exports can pick up, brighter days could be ahead for EWY.  So don’t put too much stock in the latest rate cut as clearly more will have to be done in Korea in order for stocks in the country to breakout.

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