The MSCI Korea Index is one of the most widely used benchmarks by funds that have Korean equity exposure. Its constituents have a total market capitalisation of US$529 billion as of end-July 2012, covering about 84% of the South Korea equity universe.
As of this writing, the MSCI Korea Index has a total of 105 component stocks, roughly half of those in the KOSPI 200 Index, which is another popular index tracked by ETFs with Korean equity market exposure. Most of the constituents of the MSCI Korea Index are also constituents of the KOSPI 200. In fact, their combined market capitalisation accounted for 94% of that of the KOSPI 200 Index. Unsurprisingly, the two indices have shown perfect correlation over the past 1, 3, 5, 10 years, with similar risk/reward profiles. Structurally, we view these two indices as interchangeable, although the KOSPI 200 provides a broader stock exposure than the MSCI Korea. However, from an ETF tracking perspective, we have a slight preference for the MSCI Korea Index as the smaller size stocks in the KOSPI 200 could be less liquid and lead to higher tracking costs.
Over the past three years, the MSCI Korea Index has been more correlated to emerging markets (e.g. 92% correlation to the MSCI Emerging Markets Index and 95% to the MSCI EM Asia Index) than to developed markets (e.g. 83% correlation to the MSCI World Index and 79% to the S&P 500 Index). However, this trend has phased off in the recent year with 1-year correlation at 95-98% both to emerging and developed markets. This clearly makes the MSCI Korea unsuitable as a diversification tool for investors with a global portfolio.
Interestingly, the MSCI Korea Index has shown a lower correlation with the domestic Chinese indices (e.g. 31% correlation to the MSCI China A Index and 32% to the CSI 300 Index in the past 3 years; 53% and 56% respectively in the past year). These figures suggest that ETFs tracking the MSCI Korea Index could offer good degree of diversification for investors with a portfolio concentrated in domestic Chinese equities.
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ETFs Tracking the MSCI Korea Index
In Hong Kong and Singapore, there are two ETFs tracking the MSCI Korea Index, namely the db x-trackers MSCI Korea TRN Index ETF (02848, listed in Hong Kong; IH2, listed in Singapore) and the Lyxor ETF MSCI Korea (AO9, listed in Singapore). Both ETFs employ synthetic replication to track the benchmark index.
Meanwhile in Korea, there is only one ETF tracking the MSCI Korea Index, namely the Kodex MSCI Korea ETF (A156080).
Index Construction
The MSCI Korea Index is a free-float market capitalisation weighted index representing 10 sectors across the Korean stock market. Component stocks have to fulfill MSCI’s size, liquidity and free float criteria to be included in the index. MSCI uses the official exchange closing prices to calculate the index’s value. The index is reviewed on a semi-annual basis with minor quarterly reviews to accurately reflect the evolving marketplace.
The index is top heavy, with the 10 largest constituents accounting for almost 53% of the total market capitalization of the index. The index also has a large concentration in the IT sector at 35%, with technology giant Samsung Electronics (005930) accounting for 24% of the index. Other major sector weights include consumer discretionary (18%), industrials (13%), financials (13%) and materials (11%). Except from the heavy weight in Samsung Electronics, stock concentration is minimal, with Hyundai Motor accounting for 6% of the index and the remaining 103 stocks with individual statistical weights below 4%.
MSCI Korea Index Industry Weights
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Fundamental Performance Drivers of the Index
South Korea is the fourth-largest economy in Asia after China, Japan and India. It is an export-driven economy (e.g. exports of goods and services accounted for 56% of GDP in 2011) with solid fiscal fundamentals. However, the slowing of the global economy in 2012 has weighed on its performance. In July 2012 the Bank of Korea lowered borrowing rates for the first time in more than 3 years. The Bank cut the main benchmark rates by 25bps to 3%, while slashing its GDP growth forecast for 2012 from 3.5% to 3.0%, which would mark the slowest growth since 2009. The potential for a more pronounced growth slowdown upon further deterioration of global economic conditions is one of the main risks facing investors in the country. Besides, on a general note, investors should always remain aware that political and military tensions between South and North Korea always tend to have a negative impact on South Korea’s financial markets.
Samsung Electronics (005930) accounts for 24% of the index and it is by far its largest holding. This technology giant is a global leader in manufacturing of consumer electronics, mobile phones, memory chips and LCD panels. It has become the world’s largest handset maker with a 32.6% market share of the world’s smartphone market, followed by Apple (AAPL) at 16.9%, according to IDC. We expect the solid demand in electronic products, such as tablet PCs and smartphones, to continue driving Samsung’s profitability. However, the slowdown in global economic conditions, not to mention the severe competition in this particular marketplace, could weigh on Samsung’s earnings and share price performance. Adding together other technology firms, IT exposure accounts for 35% of the index portfolio.
Consumer discretionary is the second largest exposure of the MSCI Korea Index, accounting for 18% of its market capitalisation. This exposure consists largely of carmakers and their related business. The main exponents are Hyundai Motor (the second-largest holding of the index at 6%), Kia Motors (3%) and Hyundai Mobis (3%). Sales for these companies are highly export-driven (e.g. 66% for Hyundai and 82% for Kia for the first 7 months of 2012, according to company data).
The other three main sector exposures for this index are industrials (13%), financials (13%) and materials (11%).
· Within the Industrials sector we find some of the world’s largest shipbuilders, such as Hyundai Heavy Industries (009540, 2%) and Samsung Heavy Industries (010140, 1%) as well as construction and engineering firms.
· The Financials sector consists of banks, securities and insurance firms. The highly indebted household situation of the nation is an area to be cautious on –– debt-to-disposable income ratio rose to 163.7% in 2011 from 158% in 2010.
· The Materials sector consists of the steel maker POSCO (005490, the third-largest holding of the index at 4%) and chemical companies such as LG Chem (051910, 2%).
· The industrials and materials sectors are export-driven, which could be affected by the global economy and also intense competition.
Jackie Choy is an ETF Strategist with Morningstar.
