Finding the right amount of international exposure for a portfolio often comes down to finding a balance between emerging or developed markets. An investment in South Korea can cover both bases. The country has historically been seen as an emerging market, but its economy now exceeds $1 trillion in annual economic output and is already the 15th largest in the world.
South Korea’s strong middle class, sound government policies and world-class manufacturing capabilities make it a hybrid among emerging markets. “We call it an ‘emerged market’” says Joe Cunningham, executive vice president at Horizons ETF Management.
A better name may be “export market.” Indeed, more than half of its economy is generated by exports, with fully one-quarter of all South Korean exports heading to China. And free trade agreements signed with the European Union and the U.S. in 2011 are laying the foundation for further export growth.
Horizons, which is 85 percent-owned by South Korea’s Mirae Asset Management, is a relative newcomer to U.S. investors. The firm manages $9 billion in global ETF assets, mostly split between Asia and Canada, and recently launched the Horizons KOSPI 200 ETF (HKOR). That fund joins two other domestic Horizons funds: The Horizons S&P Financial Select Sector Covered Call ETF (HFIN) and the Horizons S&P 500 Covered Call ETF (HSPX).
The Horizons South Korea ETF’s biggest competitor is the popular iShares MSCI South Korea Capped ETF (EWY), which has more than $4 billion in assets under management. But Horizons believes it offers advantages over its entrenched rival.
“We’re cheaper and deeper,” Cunningham says, referring to HKOR’s 0.38 percent expense ratio, which is unusually low for a country-specific fund. The EWY fund, in contrast, sports a 0.62 percent expense ratio.
HKOR also digs deeper into the Korean market, with stakes in the 200 companies that make up the country’s Kospi index. The EWY fund owns the top 105, as benchmarked by MSCI, and is geared towards the country’s conglomerates, known as chaebols. Its top 10 holdings account for 50 percent of the portfolio.
As such, the Horizons fund offers greater exposure to small and mid-cap companies. That could prove to be a wise move because the South Korean government is trying to wean the country from the overwhelming influence of chaebols, which account for more than 80 percent of GDP.
As witnessed in Japan over the past two decades, massive conglomerates with inter-locking stakes in each other’s operations can stifle innovation. Park Guen-hye, South Korea’s president, has been curtailing tax breaks for chaebols, and is instead shifting them to start-up companies. Still, with 23 percent of the fund invested in tech giant Samsung, the HKOR fund can’t fully avoid the chaebol exposure.
For sure, South Korea’s export-oriented economy has felt the impact of a slowdown in global trade: According to the IMF, its economy grew less than three percent in 2012 and 2013, though it is expected to grow a more robust 3.7 percent this year. The slowdown in growth explains why the Kospi index has lost six percent of its value over the past three years (while the S&P 500 has risen roughly 39 percent).