Korea ETFs Get Boost From Rate Hike

by on July 9, 2010 | ETFs Mentioned:

Once upon a time, when business at Lehman Brothers was booming and few investors knew what a credit default swap even was, surprise interest rate hikes would send markets into a tailspin, worrying investors that higher borrowing costs would curtail growth and ultimately depress earnings. As further evidence that we are operating in the “new normal” environment, unexpected interest rate increases are no longer the devastating developments they once were, and in fact are now likely to give markets a boost [see ETF Plays On The Next Developed Markets].

The latest example comes out of South Korea, where the central bank pushed up the interest rate on Friday for the first time in nearly two years. Because South Korea had experienced a relatively speedy and robust recovery, many had expected the central bank to begin raising rates last year. But then Korean politicians began to sit in on Bank of Korea meetings, and rate hikes never materialized. “The move came as a surprise, but only because economists who had once expected Korea to be an early mover on rates had thrown in the towel,” writes Mohammed Hadi. “The fundamental argument supporting a rate rise has been in place since early this year: As Korea’s economy has rebounded to its pre-crisis health, interest rates have not.”

Wild Ride Continues

ETFs offering exposure to South Korean equity markets surged on news of the rate hike, presumably as investors viewed  the willingness to raise rates as an optimistic outlook on the country’s economy. With unemployment around 3.2% and inflation well below the 3% target, South Korea is a potentially interesting investment opportunity.

There has been no shortage of drama surrounding Korea’s equity markets this year. After the sinking of a navy vessel, allegedly by a North Korean torpedo, investors fled from South Korean equities amidst fears that the escalation of tensions would lead to armed conflicts. But so far cooler heads have prevailed, and South Korean stocks ultimately reclaimed much of the ground lost in panic selling [see Fears Of Second Korean War Weigh On EWY].

Last month, South Korea again missed out on a promotion to “developed” market status by index provider MSCI. Despite meeting “most developed markets criteria of the MSCI market classification framework, notably economic development, market size and liquidity,” South Korea was kept in “emerging” status. While that development may have been disappointing for the country, it likely saved equity markets from a tumble [see Ticking Time Bomb Under EEM].

Next up was news of a breakthrough in trade talks with the U.S., setting the stage for a significant increase in economic activities between the two countries [see SKOR In Focus On Trade Talks]. Finally, Korean market stood out as a potential beneficiary of a more flexible Chinese currency; if the yuan’s peg to the dollar is eased (or eliminated altogether), South Korean goods become immediately more competitive to overseas buyers, potentially boosting demand for semiconductors and other exports.

Korea ETF Options

For investors looking to establish exposure to South Korean equity markets, there are two primary options:

  • iShares MSCI South Korea Index Fund (EWY): This ETF offers exposure to the MSCI South Korea Index, a benchmark dominated by large and mega cap companies. Reflecting the composition of the South Korean economy, EWY is heavy in hardware (23%) and industrial materials (20%) [also see Three Tech-Heavy International ETFs].

  • IQ Korea Small Cap ETF (SKOR): Unlike EWY, this ETF focuses exclusively on small cap equities, thereby accessing companies that tend to be more dependent on the local economy as opposed to global economic trends [see holdings of SKOR here].

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Disclosure: No positions at time of writing.