EWY: Long Exposure To South Korea’s Technology Focused Economy (NYSEARCA:EWY)

Introduction

It’s fitting to cover iShares MSCI South Korea Capped ETF (NYSEARCA:EWY) at a time when the world’s 10th largest economy is looking for ways to woo investors to its flourishing but somewhat shielded securities markets.

The country is easing regulation of financial markets in a bid to garner interest from abroad in its quest to graduate to MSCI’s much coveted developed markets status.

Registration requirements for investors will be dumped in favor of a simplified KYC identification process via passport and investors will be able to trade Korean stocks.

By getting upgraded to developed market status by the famous US ratings agency, the country’s financial regulatory authorities hope to generate more international interest and capital inflows into domestic equities markets.

That in itself may detract from some of the utility packaged ETFs had, particularly for seasoned stock pickers. Yet for the rest of us, the relevance of iShares MSCI South Korea Capped ETF remains present. My outlook on the fund remains neutral at present.

An overview of Korean economic data suggests a slowing of the economic but comparably low inflation coupled with a tight labor market.

For years, MSCI has continued classifying South Korea as an emerging market. Yet with gross domestic product per capita adjusted for purchasing power parity at ~$44K USD, it’s a tough sell when juxtaposed against its neighbors – China ($17K USD), and Japan ($40K USD). Looking further South into Asia, distant neighbors such as Vietnam ($10K USD), Thailand ($17K USD), and Malaysia ($26K USD) perhaps more accurately reflect what an emerging market really is.

The country has been heaped with other poorer Asian states, predominantly due to its arcane registration requirements for investors wagering on its capital markets and its rejection of offshore Won trading.

With troubled memories of the Asian financial crisis ever present in the minds of regulators, that may be a step too far for now. In any case, the coming liberalization of the country’s capital markets provides an opportunity to look at iShares Korea focused ETF.

Despite massive rollercoaster swings in volatility, EWF has managed to outpace SPY over its lifetime.

Product Overview

iShares MSCI South Korea capped ETF is a fund managed by BlackRock Inc, investing in the public equity markets of South Korea. It invests in Korean equities covering a range of sectors, handpicking both growth and value stocks.

The fund’s aims are to track the MSCI Korea 25/50 Index, by using a representative sampling technique. The fund was launched in 2000.

iShares MSCI South Korea capped ETF is a $3.69B broad equity fund comprised of roughly 100 underlying securities. The top 10 underlying equity positions make up approximately 48% of the fund, suggesting a degree of concentration.

The product avoids using leverage making this an appropriate fund for long-term holding. Accordingly, the fund also pays an annual dividend of about 1%. Fees remain relatively competitive at 0.57% and options markets are available for traders looking to generate additional revenue streams through perhaps selling calls against their holdings.

The fund is over 20 years old, having been launched by BlackRock in 2000. The fund remains liquid – approximately $200M in securities change hands daily and spreads of solely 2 basis points emphasize this.

Product Structure

The product is designed in a way to provide greatest exposure to large cap liquid Korean securities. Out of the $3.6B in assets under management, 60% of these are made up of large cap securities (> $12B) and the remainder being made up of mid cap players (~40%). Unsurprisingly, information technology makes the biggest showing (~34%), followed by financials (~12%), industrials (~11%), materials (~10%) and consumer discretionary (~10%).

Returns year to date for most of the underlying securities has been resoundingly negative, led by outlier Samsung Electronics (furthest right of the screen) which weighs 22% of the fund.

Korea remains home to one of the largest semi-conductor manufacturers (Samsung Electronics) and has a concentrated market of economic players dominated by its Chaebol (large concentrated players diversified across many industries), a tribute to post Korean War history.

Over the past year, Samsung Electronics’ woes have been the biggest contributor to fund losses.

It’s been a tough time if you have been in semi-conductors and if guidance and price action given by some of the big US manufacturers such as Intel (INTC) are signs of things to come, it looks like the semi-conductor industry may quickly face a lagging but ever present over-capacity issue. Perhaps bad news for Korea whose economy is so heavily dominated by the Korean electronics giant, Samsung.

Financials and diversified materials plays have provided some respite yet the weightings are not consequent enough to outstrip some of the larger fund losers.

Fund flows showed sizable outflows at the outbreak of the war in Ukraine. Things have somewhat stabilized since then.

ETF Returns & Yields

The past 5 years have been a tumultuous period for EWY, reflective of a global economy in crisis. Over that period, the fund has lost -19.95% but the most striking aspects have been sheer volatility during the global pandemic, subsequent rebound, and challenging trading year during 2022.

It is also worth noting that the fund pays a 1.12% distribution annually.

Risks

While some stability has recently come to the markets, its worth highlighting larger macro & geo-political risks Korea is particularly exposed to. The country remains locked between an increasingly boisterous North Korea not afraid to taunt Japan with missile fly-bys and South Korea by airspace incursions.

The neighborhood is particularly steeped in geo-political and economic tension, vestiges of World War 2 between Japan and China ever present. China’s historical claim to Taiwan makes the vicinity one of the most politically fraught.

South Korea entertains a heavily concentrated industry base, marked by the Chaebol that took the once agrarian economy out of poverty over the last 70 years. That concentration implies perhaps greater systemic risk and less flexibility when facing exogenous shocks.

Vestiges of the Asian Financial Crisis remain. The 51 million strong population has also been exposed to government corruption scandals. Labor costs have increased markedly, and exports have plunged, forcing the export technology focused society into a current account deficit.

Notwithstanding, 2022 was a relatively good year for trade with $680B of exports being driven by semi-conductors, automotive, petrol products and battery cells.

China, Korea’s biggest trading partner is facing its own internal challenges, pushing the government to revise 2023 export forecast to fall -4.5% on the back of a global economic slowdown and weak chip prices.

Key Takeaways

For investors looking for passively managed exposure to Korea’s well developed capital markets, a foray into EWY – iShares MSCI South Korea Capped ETF might be worth a try. As the country grapples with a global economic cooling, different initiatives, including the liberalization of capital markets for foreign investors, are underway.

For hardened stock pickers, that provides real advantages. For the rest of us, EWY provides a flexible, liquid, and cost-effective way to gain risk exposure to the world’s 10th largest economy.