This Undercover Emerging Market Could Be Asia’s Next Big Hit

Smart investors are always keeping their eyes toward other frontiers, turning over stones to find value where others may least expect it.

For many, that means unearthing lesser-known opportunities outside of the developed world and looking to the emerging markets of Europe, Africa, Latin America and Asia.  

#-ad_banner-#As a fan of international investing, I’ve spent considerable time digging through BRICs (Brazil, Russia, India and China), MINTs (Mexico, Indonesia, Nigeria and Turkey) and everything in between.  Through all of that research, I discovered one country that not only lacks the coverage it deserves… but presents a potentially lucrative opportunity. 

For years, South Korea has been caught in the shadow of some of its more recognized neighbors like China, Indonesia and Vietnam. And there’s a good explanation: the country’s high degree of economic advancement may have tipped the scales and pushed it out of emerging market territory and into the company of more developed nations.

What makes South Korea an attractive investment in my book?  

•    Impressive economic advancement – The small country is the seventh-largest exporter in the world and the fourth-largest economy in Asia.  
•    High concentration of global tech leaders – Household names like LG, Samsung, Kia and Hyundai call South Korea home.
•    A business-minded government – President Park Geun-Hye outlined a three-year economic innovation program that intends to make Korea more competitive with neighboring Japan, China and Taiwan.

While we could argue the merits of each Korean company individually, my recommendation is to find a diversified, country-specific ETF when looking to invest in a market like Korea.  The iShares MSCI South Korea Capped Index Fund (NYSEArca: EWY) is a clear winner.

The ETF’s holdings are a venerable who’s who of well-known South Korean global conglomerates. With $4.7 billion in net assets, EWY is the largest and most liquid Korean index fund.  

See below for a breakdown of the fund’s top ten holdings and their percentage weights:

Analysts believe that Korean cash-rich companies, like the ones above, will begin to pay larger dividends in the coming months. This expectation helped prop up EWY by nearly 4% in the past month alone.  The index is now reaching pre-recession levels, but it remains undervalued compared to the major indexes of more developed markets like the United States. 

A recent interest rate cut by the Bank of Korea, the country’s central bank, also helped bolster growth for the fund.  The August 14 cut was the first in over a year and is intended to foster consumer confidence and ignite the local property market.  

Current trading ranges of EWY support a higher share price and outside investors are beginning to take note.  

Capital flows into the ETF increased by almost $112 million during the first two full weeks of August. To lend some perspective, inflows for the iShares MSCI Japan ETF (NYSEArca: EWJ) lost $48.8 million in the same time period.  The undervalued argument continues when comparing valuations to competitors like Taiwan, India, Malaysia and the Philippines. Korea is still trading at a surprising discount.

Big funds and institutional investors are on board with the South Korean ETF as well.  According to EWY’s most recent 13F SEC filings, BlackRock, Inc., an investment management firm, owns approximately $117 million of the fund.  Bank of America bests that number with an investment of nearly $200 million. Goldman Sachs, Morgan Stanley and Wells Fargo round out the list of notable investors.  

Recent ratings from sell-side firms validate my confidence. S&P Capital IQ views the ETF as “overweight,” or a strong buy. Standpoint Research mirrors that positive sentiment and set a price target of $78. The fund currently trades at around $66.

Risks to consider:  South Korea’s strong export economy, while one of the country’s greatest strengths, opens the possibility for cracks in its armor.  It is well-documented that Korea has a very low birth rate, meaning that dependence on external growth through exports is a real concern.  Currency risk also needs to be heeded, as EWJ does not hedge foreign exchange moves between the won and USD.

Action to take –> Adventurous investors looking to park cash in a lesser known Asia play should strongly consider South Korea.  Tech dominance, impressive consumer recognition, low volatility and a discounted valuation present the case for an attractive long-term hold.  

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