Free Trade Agreement Puts South Korean ETFs In Focus

by on December 6, 2010 | ETFs Mentioned:

South Korean equities have been in focus as of late but for all the wrong reasons; rising tensions with the often volatile North finally bubbled over earlier this year as the communist regime shelled an island of their long-time South Korean rival. The South Koreans responded in kind, launching mortars of their own while scrambling jets in preparation for any further escalation [see Korea ETFs Plummet As North/South Tensions Flare]. Unsurprisingly, this situation led to a rapid sell-off in Korean equities as investors fled the hot spot for safer markets with less geopolitical risk. However, as cooler heads prevailed investors slowly returned their assets to the dynamic South Korean market in an attempt to find beaten down companies that were unfairly punished by the rising tensions. This trend looks likely to continue given recent events that took place between the leaders of South Korea and the U.S. which could give Korean firms a much needed boost heading into 2011.

After much delay and political concerns, a free trade deal between the United States and South Korea has finally been approved, potentially giving a boost to both nations’ economies. The pact will remove 95% of tariffs between the two nations within five years helping to cut down barriers between two of the world’s top fifteen economies. Both sides made concessions in order to hopefully make the deal more palatable to their respective legislative branches as the Koreans protected their pork industry while the Americans received several concessions related to automobile tariffs. “To some who say that this was a one-sided concession, I cannot agree because I feel that the agreement was a win-win situation for both countries,” said Korean Trade Minister Kim Jong-hoon about the deal. “South Korean car sales to the U.S. will see limited impact from the revision.”

The deal is being touted as the biggest free trade deal for the U.S. since NAFTA and could significantly increase bilateral trade in the near-term and even help the U.S. to increase exports to the country by close to $11 billion a year, potentially creating thousands of much needed jobs back in the states. From the Korean side, economists are predicting that the deal will boost the nation’s GDP by 0.6% per year for the next ten years and while 34,000 jobs are expected to be created every year during the time period as well [read ETFs For The 'Next 11' Economies].

Hold on a second…

Now will likely come the hard part for the Obama administration as the FTA must be ratified by both houses of Congress before it can become law. Of particular concern is likely to be if the deal remains balanced enough to garner support from both the Democratic majority in the Senate and the Republican majority in the House. Both groups are likely to have their own misgivings about the deal, especially given how little reaching across the aisle there has been in the past few years and the often-controversial nature of the NAFTA agreement. Meanwhile, a similar situation is brewing in Seoul as anti-free trade protesters have stepped up their criticism of the agreement in recent days. However, this has not been limited to protests on the streets as several political parties have joined in including Park Jie-won, floor leader of the Democratic Party, who called the new agreement a “humiliating and treacherous deal.”

If both Korea and the U.S. are able to move past these political issues it could end up being a huge boost to the Korean economy and could continue the nation’s free trade agreement boom. The country already has FTAs with both the ASEAN bloc and Chile plus, starting in the next few years, the small rapidly developing nation in north Asia could now have FTA with both the U.S. and the EU; two economic blocs that combine to make up close to half of the world’s GDP. Should this free trade bonanza come to pass, it could end up being a blessing for the nation’s many exporters and decrease costs for consumers at home as well. Thanks to the historic nature of this event,  we highlight two ETFs that offer investors exposure to the in-focus Korean market:

IQ South Korea Small Cap ETF (SKOR)

For investors seeking companies that are likely to benefit from the FTA’s positive effects on consumption, SKOR makes for an interesting pick. SKOR tracks the IQ South Korean Small Cap Index which is a market cap-weighted benchmark seeks to provide investors with a means of tracking the overall performance of the small capitalization sector of publicly traded companies domiciled and primarily listed on an exchange in South Korea. Currently, the fund has 102 holdings with heavy weightings in the industrial materials (19%) and consumer goods (12.1%) sectors. In terms of market cap levels, 54% of the fund goes towards mid caps while the remainder is invested in small and micro cap securities. SKOR charges investors an expense ratio of 79 basis points but has managed to return 6.1% to investors year to date and 25% over the past half year period [read Playing The Emerging Markets Though Small Cap ETFs].

iShares MSCI South Korea Index Fund (EWY)

If you are more sold on the boost in exports to the U.S. thanks to this deal, than EWY could make for a quality choice. This popular iShares fund tracks the MSCI Korea Index which is a benchmark that measures the performance of the South Korean equity market with a heavy focus on large cap names. The fund’s top holdings include electronics giant Samsung (15.1%), as well as steel maker Posco (5.6%) and car manufacturer Hyundai Motor (4.8%). Ironically, this fund also has 102 securities, except unlike SKOR, this fund has a heavy focus on IT (26.3%) as well as a near 15.5% weighting in each of the following four sectors; industrials, financials, consumer discretionary, and materials. EWY charges a slightly lower expense ratio than its small cap counterpart coming in at just 63 basis points. Additionally, the fund has had better luck in terms of return as well, posting a gain of 19.5% so far in 2010 [also see ETF Plays On The Next Developed Markets].

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Disclosure: No positions at time of writing.