IndexIQ continues to expand its suite of small cap international equity ETFs, announcing on Wednesday the launch of the IQ South Korea Small Cap ETF (SKOR). SKOR will seek to replicate the performance of the IQ South Korea Small Cap Index, a benchmark that includes about 100 small cap Korean stocks. The weighted average market cap of the underlying index is about $470 million, a fraction of the size of most Korean equities included in U.S.-listed ETFs.
The Case For Small Caps
International equity ETFs cover nearly every corner of the globe, but gain exposure to non-U.S. markets primarily by replicating indexes composed of the largest and most liquid stocks listed in a particular country. As a result, many international equity ETFs are dominated by mega-cap equities that often generate significant portions of revenue and earnings from overseas markets.
The iShares MSCI South Korea Index Fund (EWY) is a good example. Samsung Electronics, which makes up about 19% of fund assets, generates the majority of revenue from outside of South Korea. In 2008, about 21% of sales came from the Americas, with another 28% coming form Europe and another 16% from China. So while Samsung is headquartered in South Korea, it depends as much on the health of the U.S. and Chinese economies as it does on the local South Korea markets.
The mega-cap focus of the first generation of international equity ETFs has created an opportunity for funds focusing on smaller companies in international markets. “Investors targeting South Korea typically have been required to invest in funds with broad-based exposure to large cap and global companies domiciled or operating in this market,” said Adam Patti, chief executive officer at IndexIQ. “However, the South Korean economy has its own important dynamics, which are perhaps best captured thorough small capitalization companies. The growth of South Korea’s economy has been driven by a robust domestic consumer-class, coupled with an export-driven trade platform, a high-growth technology sector, and the unique status as one of the world’s most innovative countries.”
International exposure through small caps isn’t necessarily better than exposure established through mega caps, but it is certainly very different. A study of performance of small cap international ETFs in 2009 revealed some significant gaps between small cap and large cap Brazil ETFs (BRF and EWZ, respectively), as well as funds focusing on Japan, the EAFE region, and China (see the full breakdown here).
Earlier this month, IndexIQ launched small cap ETFs targeting the economies of Australia (KROO) and Canada (CNDA). Both received a warm reception from the markets, as average daily volumes have already topped 25,000.
The Case For South Korea
South Korea has established itself as one of the world’s leading economies for technological development and innovation, and has been ranked by some reputable sources as the most innovative country in the world. South Korea is now the fourth largest economy and 15th largest in the world. Seoul was recently named the ninth most economically powerful city in the world, and is expected to continue its rapid growth in coming years.
South Korea serves as an excellent example of an emerging market that has successfully transitioned to developed status (although some index providers are yet to make this upgrade). The largest of the four Asian Tigers, South Korea is now home to the world’s largest department store and will soon boast the world’s second-tallest building. It became the first Asian nation to host the G-20 Summit (scheduled for November in Seoul), and is among the ten largest exporters globally.
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Disclosure: No positions at time of writing.