Update: db x-trackers MSCI Korea Index UCITS ETF

Over the past three years, the MSCI Korea Index has been more correlated to emerging markets (e.g. 83% correlation to the MSCI Emerging Markets Index and 85% to the MSCI EM Asia Index) than to developed markets (e.g. 60% correlation to the MSCI World Index and 44% to the S&P 500 Index). These figures indicate that this ETF could offer some degree of diversification benefit for international investors.

Interestingly, the MSCI Korea Index has shown a lower correlation with the domestic Chinese indices (e.g. 18% correlation to the MSCI China A Index and 17% to the CSI 300 Index in the past 3 years; at around -50% in the past year). These figures suggest that this ETF has offered good degree of diversification for investors with a portfolio concentrated in domestic Chinese equities in the past. However, this correlation figure has fluctuated quite widely over shorter periods. For example, it was around -50% for the 12 months ended January 2015, 0% for the 12 months ended September 2014, versus 83-86% for the 12 months ended May 2014.

South Korea accounts for quite a considerable weighting in some of the emerging market equity indices (e.g. 15% in the MSCI EM Index and 22% in the MSCI Emerging Asia Index). It is worth noting that MSCI has removed South Korea from the list for potential elevation to developed market status, while FTSE and S&P already considers it as a developed market in its international index. We therefore advice investors to check their existing exposure to South Korea to avoid unintentionally creating concentrated exposure in Korean equities and “emerging markets” according to the chosen definition.

Fundamentale Analyse

South Korea is the fourth-largest economy in Asia after China, Japan and India. In the past two years, the Korean government implemented various stimulus packages, including cutting interest rates from already low levels (last cut in October 2014 by 25bps). The economy is recovering gradually, as GDP grew by 3.3% in 2014, up from 2.8% in 2013 and 2.0% in 2012. However, the trend has weakened in 2014 as GDP grew at 2.7% YoY in Q4 2014, down from 3.5% YoY in Q2 2014. The government also lowered its forecast GDP growth for 2015 to 3.9% from 4.2%. It is worth noting that, due to its export-driven nature, Korea’s economy would likely be sensitive to changes in global economic conditions. The weakening of the Yen against the Korean Won over the past two years (Yen -22% vs. Korean Won -0.4% against the US dollar) has made Japanese goods far more competitive, placing serious pressure on Korean manufacturers.

Samsung Electronics (005930) accounts for 24% of the index and it is by far its largest holding. This technology giant (manufacturer of consumer electronics, mobile phones, memory chips and LCD panels), has become the world’s largest handset maker with a 20.0% market share of the world’s smartphone market, followed by Apple (AAPL) at 19.9% as of Q4 2014, according to IDC. The market share gap between Samsung and Apple has narrowed significantly from Q4 2013 when Samsung was at 28.8% and Apple at 17.4%. Competitive pressures have intensified from Apple’s launch of larger screen smartphones and new phones from other brands, in particular the newly emerged Chinese smartphone manufacturers. Samsung’s IT & Mobile communication segment accounts for about 60% of its operating profits. Adding other IT firms, IT exposure accounts for 41% of the index.

Consumer discretionary is the second largest exposure of the index, accounting for 16% of its market capitalisation. This exposure consists largely of carmakers and their related business. The main exponents are Hyundai Motor (the third-largest holding of the index at 4%), Hyundai Mobis (3%) and Kia Motors (2%). Sales for these companies are highly export-driven (e.g. 64% for Hyundai for the full year 2014).

The other three main sector exposures for this ETF are financials (14%), industrials (10%) and materials (9%). The financials sector consists of banks, securities and insurance firms while the industrials sector consists of some of the world’s largest shipbuilders as well as construction and engineering firms. The materials sector includes the steel maker POSCO (005490, the eighth-largest holding of the ETF at 3%) and chemical companies. The industrials and materials sectors are largely export-driven and so their performance would be affected by the global economy, intense competition, and also currency impact. As it pertains the financials sector, the highly indebted household situation of the nation is an area to be cautious on (e.g. debt-to-disposable income ratio remained at a high level at 153.4 in 2012, well above the Organisation for Economic Co-operation and Development average of 121.3; and household credit outstanding grew by 6.6% YoY in 2014.).

Indexkonstruktion

This ETF tracks the MSCI Total Return Net Korea Index, a free-float market capitalisation weighted index representing 10 sectors across the Korean stock market with 107 constituent stocks as of this writing. 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 52% of the total market capitalization of the index. The index has a large concentration in the IT sector at 36%, with technology giant Samsung Electronics (005930) accounting for 24% of the index. Other major sector weights include consumer discretionary (16%), financials (14%), industrials (10%) and materials (7%). Except from the heavy weight in Samsung Electronics, stock concentration is minimal, with the remaining 106 stocks with individual statistical weights below 5%.

Fondskonstruktion

Effective from 25 September 2014, the ETF switched from synthetic replication to physical replication. The ETF utilises full replication to track the index. The ETF is allowed to engage in securities lending in order to improve the ETF’s tracking performance. Deutsche Bank AG through its Frankfurt head office and its London and New York branches, acts as the lending agent. The ETF may lend out a maximum of 30% of its portfolio (0% as of 27 February 2015). According to the securities lending policy, the collateral amount is required to be 100-110% of the exposure of the lent asset and the collateral may comprise stock, bonds and cash. Lending revenue is split 70/30 between the ETF and the lending agent, respectively. db x-trackers fully discloses all details pertaining to securities lending for this ETF in its website.

Gebühren

The ETF levies a total expense ratio (TER) of 0.65%. This is in-line with other Hong Kong and Singapore-listed ETFs tracking the MSCI Korea Index. Other costs potentially borne by the unitholder but not included in the TER include bid-ask spreads and brokerage fees when buy and sell orders are placed for ETF shares.

Alternativen

This ETF is domiciled in Luxembourg and is listed in Hong Kong, Singapore and various exchanges in Europe. There are a number of ETFs tracking the MSCI Korea Index, including the Lyxor ETF MSCI Korea (AO9, listed in Singapore and various exchanges in Europe, TER 0.65%), Kodex MSCI Korea ETF (A156080, listed in Korea, TER 0.37%), CS ETF (IE) on MSCI Korea (CSKR, listed in various exchanges in Europe, TER 0.65%), HSBC MSCI Korea ETF (HKOR, listed in various exchanges in Europe, TER 0.60%), iShares MSCI Korea (IKOR, listed in various exchanges in Europe, TER 0.74%), iShares MSCI South Korea (IKO, listed in Australia, TER 0.59%) and iShares MSCI South Korea Capped Index Fund (EWY, listed in the US, Mexico and Chile, TER 0.59%). Amongst these ETFs, the Lyxor ETF MSCI Korea employ synthetic replication while the others employ physical replication. In terms of AUM, the iShares ETF listed in the US is the largest at US$4.0bn, followed by its Europe version at US$495m, this db X-trackers ETF at US$308m and the Lyxor ETF at US$98m.

Investors seeking Korean equity market exposure may also consider ETFs that track alternative indices, such as the KOSPI 200 Index, which offers similar exposure but includes a higher number of constituent stocks.