Economic and military tensions weigh on South Korea ETFs

Jan 4th, 2017 | By | Category: Equities

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Exchange traded funds tracking South Korean equities may experience a downturn in 2017 as the domestic economy has taken a turn for the worse and the threat from north of the border has increased.

Economic and military tensions weigh on South Korea ETFs

The MSCI Korea Index returned 9.7% during 2016, slightly below the MSCI Emerging Markets Index return of 11.6% over this period.

Last month the South Korean government lowered its GDP forecast for 2017 to 2.6%, below its 3% target, due to weak domestic demand and lower than projected job growth, as reported by Asia Times.

It is still the fourth largest economy in Asia, but faces a number of headwinds, including industrial competitiveness, slowing corporate earnings and a major political scandal which resulted in President Park Geun-hye stepping down over her inappropriate relationship with confidante Choi Soon-sil.

ETFs have not yet shown signs of the strain, however.

Most European-listed ETFs tracking Korean equities follow the MSCI Korea Index which returned 9.7% during 2016, although this slightly below the MSCI Emerging Markets Index return of 11.6% over this period.

The largest South Korea ETF in Europe is the $435m iShares MSCI Korea UCITS ETF (LON: IKOR). The fund has returned more than 35.7% in GBP terms over the past 12 months, and only slipped 0.2% over the past quarter, according to Bloomberg data.

But volatility could be set to test these funds.

South Korea is an emerging market – according to some classifications – and the future returns of this asset class is uncertain thanks to rising interest rates in the US and its President-elect Donald Trump vowing to adopt a more isolationist stance on international trade.

One of the largest threats, for South Korea specifically, is its northern neighbour. Under Kim Jong-Un, North Korea tested its nuclear missile program twice in 2016 alone. Some experts claim the country is just years away from launching a nuclear warhead that could reach the US, but South Korea is at most immediate risk.

South Korea-focused ETFs also exhibit sensitivity to their northern neighbour’s military aggression. IKOR slipped by more than 3% in the four days after 9 September when North Korea tested a missile.

There are four ETFs listed in Europe that track South Korea, including IKOR, which is the largest but also the most expensive at 0.74% fees.

They all track the same index, which has 109 holdings, with 40.5% in information technology, 13.4% in financials and 12.7% in consumer discretionary stocks. The relatively small weighting in financials is an exception compared to many other single-country emerging market ETFs.

The $95m Lyxor UCITS ETF MSCI Korea USD (LON: KRW) costs 0.65% in annual fees and has returned more than 14.8% in USD terms in the last year.

The HSBC MSCI Korea UCITS ETF (LON: HKOD) is slightly cheaper at 0.60% fees but is a lot less liquid with only $5.4m in assets.

The third option is the db X-trackers MSCI Korea TRN Index UCITS ETF (XETRA: XMKO), which is up 16.6% over the last 12 months in euro terms. It costs 0.65% and is the second largest in AUM terms at $138m.

North Korea has also developed its cyber-attack capabilities, most recently penetrating South Korean military servers and stealing confidential documents.

Such security breaches are fuelling demand into ETFs that invest in companies fighting cyber hacks.

The ETFS ISE Cyber Security GO UCITS ETF (LON: USPY) is up 3.6% over the last 12 months in USD terms. It invests in mostly US and Japan-based tech companies and costs 0.75%. The top three holdings are Juniper Networks, Science Applications International and Check Point Software Technologies.

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